Table of Contents
What is a mid-cap fund?
Potential benefits of investing in mid-cap funds
Risks of investing in mid-cap funds
What to know before investing in mid-cap funds
The bottom line
Oct 14, 2022
6 min read
Mid-cap companies are often less well-known than their larger counterparts, but they have benefited from successful business plans that can reward investors.
Investors who seek growth but shy away from the volatility and risk that can bedevil certain equity holdings may find middle ground in mid-cap stock funds. These funds invest in the shares of companies whose individual market values range from about $2 billion to $10 billion, sandwiching them between their small- and large-capitalization counterparts.
Analysts sometimes describe mid-caps as a “sweet spot” in equity portfolios: They have survived startup pains, but haven’t encountered the profit and share price doldrums that can dog larger enterprises. Mid-caps are generally more nimble than big companies and more financially sound than little ones, which means they can offer both growth and stability.
Investment firms offer access to a spectrum of mid-cap stocks through mutual funds and exchange-traded funds (ETFs). These pooled investments track a basket of stocks of anywhere from a few dozen to hundreds or even thousands of companies. The funds seek to capture the capital appreciation of the component shares while mitigating the risk of investing in a single stock.
Most mid-caps are smaller companies that move into the mid-value tier when their stock price rises, they issue more shares, or both. Large caps can descend into the mid-cap ranks if their share price tanks. (Market capitalization is simply a company’s stock price multiplied by the number of common shares outstanding.)
Mid-cap funds can offer benefits compared to the funds of other market-cap sectors.
. Mid-cap funds track a variety of mid-cap companies in industries including consumer, financial, industrial, energy, and health care. They can provide exposure to a sector that an investor might otherwise overlook.
. Mid-cap funds invest in companies poised to expand established businesses. Many of these companies have advanced from small-cap status and have cash flow and earnings growth rates that often are faster than in larger companies.
. Mid-cap indexes have outperformed both their small- and large-cap peers over certain extended periods. The S&P MidCap 400 beat the S&P 500 and the S&P SmallCap 600 by an annualized margin of 2.03% and 0.92%, respectively, from 1994 to 2018, according to data from S&P Dow Jones Indices. But over the 10 years that ended in early August 2022, the MidCap 400 lagged behind with a total return of 11.97% compared to 13.74% for the S&P 500 and 12.35% for the S&P 600.
. Mid-cap companies can be household names, such as aluminum company Alcoa Corp. and footwear maker Crocs Inc. More typically, they're less prominent and enjoy less analyst coverage than other sectors. Many go unnoticed, limiting the attention that can spark dramatic stock price swings.
. Mid caps are no longer startups and have demonstrated staying power, giving them enhanced access to capital markets to further expand their businesses.
. Mid caps are less reliant than smaller companies on a single blockbuster product. Their variety of products increases the avenues for revenue generation and cash flow, limiting the financial impact should one product line slow.
. Larger expansion-minded companies often target mid caps in takeover deals that boost their stock price, a boon for investors.
That’s not to say mid-cap funds don’t have drawbacks when compared to their counterparts.
. While mid-cap stocks are generally less volatile than small caps, they are typically more volatile than their larger peers. Stock price fluctuations can be dramatic. Exercise company Peloton Interactive Inc. lost almost 90% of its value in the 12 months through early August 2022. Car vendor Carvana fell almost as much in that time. Both remained mid caps even with their diminished market values.
. Mid-cap funds typically don’t offer the potential for meteoric growth that small-cap companies provide. For example, there were 13 small-cap stocks that gainedmore than 20% in the first half of August 2022 while just one mid-cap company had comparable gains.
. Mid-cap companies are generally less liquid than big companies because they typically have fewer shares available for trading and lower trading volume. Mid-cap funds can invest in hundreds of stocks, compounding the limited liquidity effect.
. During times of economic distress, mid-cap funds tend to lag behind funds that track larger companies or broad equity markets. During these periods, investors shift to large caps, which enjoy greater financial cushions and product breadth for more stable returns. The Dow Jones U.S. Total Stock Market Large Cap Index of 757 stocks had an annualized total return of 14.63% over three years through early August 2022 compared with a 12.11% return for the S&P 400 Mid-Cap Index.
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Mid-cap funds provide a variety of strategies and approaches. There are several broad categories to consider.
Mid-cap index funds offer a portfolio of stocks designed to mimic the composition and performance of a financial market index. These funds are passively managed; the fund manager doesn’t deviate from the index in the component shares or their weightings. Index funds are not designed to deliver greater returns than the index itself. They typically are less expensive to own than actively managed funds.
Mid-cap index funds can focus on specific investor goals, including:
. These funds track indexes featuring stocks expected to grow faster than their peers. Mid-cap growth funds include Vanguard’s Mid-Cap Growth Index Fund, which tracks the CRSP US Mid Cap Growth Index.
. These funds mimic indexes that focus on companies that are less expensive or growing more slowly than their mid-cap peers. Value funds often track the Russell Midcap Value Index.
. These funds track indexes that invest in mid-cap companies that pay dividends. While dividends are not a mid-cap hallmark, the S&P MidCap 400 Dividend Aristocrats beat the broader S&P 400 Mid Cap Index in the year through mid-August 2022, with a total return of 3.29% compared to a negative 4.68% for the broader index.
In contrast to index funds, actively managed mid-cap funds employ a financial professional who attempts to beat the market by choosing specific stocks. Investors pay more for actively managed funds than for index funds. Theaverage expense ratio—or the amount of money charged based on assets under management—of actively managed equity mutual funds was 0.68% in 2021 compared with 0.06% for index equity mutual funds.
Aside from selecting a passive index fund or an actively managed investment, investors can choose a mid-cap mutual fund or ETF.
There are many more mutual funds than ETFs in the mid-cap arena. However, mid-cap index ETFs and actively-managed funds in the space do exist.
Mutual funds and ETFs both provide more diversification than investing in an individual stock. But there are several important differences:
. Mutual funds trade once a day when stock exchanges close. ETFs trade on an exchange throughout the day just like a stock, giving investors more control over the price they pay.
. Mutual funds typically cost an investor more than ETFs, which generally have the lowest expense ratios overall.
. ETFs can be more “tax efficient” for investors because they have fewer taxable events, such as buying and selling shares.
Mid-cap equity funds fall between small- and large-cap offerings in market value—and in their effort to balance growth and volatility. These funds can be passively managed and track a broad or targeted mid-cap index, or employ an active manager who picks stocks in an attempt to beat their benchmark. Mid-cap companies are often less well known than their larger counterparts, but they have benefited from successful business plans and staying power that can reward investors.
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