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Time To Love Midcap ETFs

But, hype aside, midcap ETFs have outperformed large- and small-cap ETFs over the past year. I'm basing that on looking at the SPDR S&P 500 ETF (NYSEArca:SPY) as a proxy for large-caps and the iShares Russell 2000 Index Fund (NYSEArca:IWM) for small-caps.

Two leading midcap ETFs-the iShares S&P 400 MidCap (NYSEArca:IJH) and the SPDR S&P MidCap 400 (NYSEArca:MDY)-have one-year total returns of 29.6 and 29.5 percent, respectively. That easily beats SPY's 21.8 percent and even IWM's 26.2 percent. Moreover, the midcap ETFs achieved these returns with risk, measured by standard deviation, only slightly greater than that of the SPY.

Today's not the day to delve into why midcaps rather than small-caps have been leading the broad recovery in equities in the past year, but the numbers don't lie.

ETF Performance" Midcap vs. Large & Small-Cap

So, how do the biggest cap-weighted midcap funds differ?

In general, stock selection for these funds is determined by the large-cap bucket above it. The iShares Russell Midcap (NYSEArca:IWR) follows the bottom 800 stocks in the Russell 1000. The Vanguard Mid-Cap ETF (NYSEArca:VO) follows the MSCI U.S. Mid Cap 450 Index. This benchmark selects stocks ranked 301 to 750 by market cap. IJH and MDY meanwhile follow the S&P 400 Mid-Cap index, which picks stocks by committee.

These selection differences drive performance for these four funds.

Year-to-date total returns fall within a 40 basis point range. And, each of the funds' one-year performances ranges within 90 basis points. VO turns in the top performance in each case-8.1 percent so far this year and almost 30 percent in the past year.

Midcap ETF Performance (Top 4 by AUM)

VO leads in another important category:direct cost. VO's annual expense ratio of 0.12 percent expense ratio ranks lowest of the four. That's less than half of MDY's 0.25 percent. (Bargain hunters take note:Two newer funds not fully discussed here also offer expense ratios in VO's range:the Focus Morningstar Mid Cap (NYSEArca:FMM) matches VO's 0.12 percent and the Schwab U.S. Mid-Cap (NYSEArca:SCHM) comes in at 0.13 percent.)

If you don't have views on a particular sweet spot for the size bucket, strong performance and low cost make a reasonably good case for picking VO. However, two caveats apply.

First, VO's daily trading volume, while robust, lags that of the other three. MDY trades roughly 10 times as many shares as VO daily and with tighter spreads. Using a limit order instead of a market order can help manage this difference. Second, Vanguard doesn't post daily holdings. So, if daily transparency is paramount to you, VO isn't the right call.

That said, these caveats should matter less to a buy-and-hold investor looking to take advantage of the outsized performance of midcap ETFs.

Don't forget to check IndexUniverse.com's ETF Data section.

Copyright ® 2011 Index Publications LLC . All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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