Overlooked opportunities in mid-caps

I’m sure most people have heard of middle child syndrome – some have no doubt experienced it themselves.

The theory is that the oldest child tends to be more reliable and conscientious – possibly because parents go by the book with their first baby. In contrast, parents tend to be more relaxed with their youngest children, who can then become more fun-loving and uncomplicated. Middle children, on the other hand, tend to get ‘lost’ between their siblings and can end up feeling excluded or misunderstood.

It’s an argument which can be extrapolated over to the investment world in recent times. Large companies have been stealing the headlines (the likes of Facebook, Amazon, Apple, Netflix and Alphabet, for example) due to their unprecedented levels of growth, while smaller companies have proven themselves to be exceptionally resilient on a global scale.

Then we have mid-caps, which although they have a number of appealing attributes for investors, can get ignored. And this could be to the detriment of an investment portfolio.
Research from Bank of America Merrill Lynch, for example, shows that for every $1 invested in mid-caps in 1978, it would be worth $199 today – versus $181 for small-caps and $139 for large-caps on a total return basis*.

With this in mind – here are a few reasons to look at mid-caps as a way of diversifying your portfolio.

Different types of company

Schroder US Mid Cap manager Bob Kaynor points to the inherent differences in the composition of the large caps versus the small and mid-cap investment universes.

He says: “Cyclical sectors – those that are more liked to the economic health of an economy -make up more than half of small and mid-caps in the US, whereas technology, internet, media and telecom – traditional secular growth areas – account for less than 20% of small and mid. This is not the case for large cap where the S&P 500 has 30% in just technology stocks, not including Amazon and Facebook, which are considered consumer discretionary.

“With an economic recovery underway, the more the domestic and cyclical small and mid-cap market is poised to outperform.”

Fast growth with lower volatility

Aberdeen Standard SICAV I – Global Mid-Cap Equity co-manager Anjli Shah says mid-caps offer some of the same attributes of fast growing small-caps, but with less volatility.

She says: “We feel that companies in the mid-cap sector typically dominate their respective niches, operate in attractive industries, are not dependent on external factors to succeed, have strong and stable management teams and attractive environmental, social and governance (ESG) credentials.”

UK recovery sweetspot

It’s no secret that UK mid and small-caps have been through the wringer in the past five years, courtesy of Brexit and the Covid pandemic. So, it was a surprise to read that both indices had recently approached all-time highs**.

In any normal situation, now would probably be the time to think about cashing in – but on this occasion it feels like there is plenty more progress to be made as the economy begins to return to some semblance of normality. And there is an argument that UK mid-caps do not look particularly expensive given the UK recovery is still lagging compared to other parts of the world.

You can hear more about this part of the UK market in this podcast with Chris St John, manager of AXA Framlington UK Mid Cap:

The ESG factor

Engagement is an important factor for managers in the ESG space – an area mid-caps have an advantage. BMO Global Responsible Equity co-manager Nick Henderson explains: “From an engagement perspective, we want to drive each of the businesses we invest into a better place – and we have found it is far easier to drive engagement with management teams in the mid-cap space.”

Another fund to consider in this area is Federated Hermes Global Emerging Markets SMID Equity. Focusing on small and medium-sized companies across emerging markets, as with all Federated Hermes products, ESG is an integral part of this fund’s investment process. It avoids stocks involved in the likes of fossil fuels, tobacco and weapons.

*Source: etftrends.com
**Source: Stifel – UK Mid and Small-Caps – April 2021
***Source: USnews.com