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How to Best Make Use of Mid-Cap ETFs

This article was originally published on ETFTrends.com.

The SPDR Mid-Cap 400 (MDY) and other mid-cap exchange traded funds are lagging the S&P 500 this year. Over the long haul, that is not the norm and investors should not gloss over mid-sized companies.

Mid-cap companies are slightly more diversified than their small-cap peers, which allows many mid-sized companies to generate more consistent revenue and cash flow, along with providing more stable stock prices. Additionally, they are not so big that their size would slow down growth. Increased mergers and acquisitions activity could be just what mid-caps need to catch up to large- and small-cap stocks.

Despite the long-term potential of mid-cap stocks and the related ETFs, advisors and investors are often underweight this market cap segment.

“But mutual fund and ETF ownership data shows investors are underweight mid-caps stocks. Of the funds in the US large-, mid- and small-cap Morningstar categories, mid-cap funds make up 8% of all addressable assets,” according to State Street Global Advisors. “Given that mid-caps represent 12.08% of the market cap of the S&P Total Market Index, it is clear the investment community is underinvested when it comes to mid-caps.”

Mid-Cap Advantages

The mid-cap category has also outperformed their larger peers, but with lower volatility than small caps. Moreover, the returns of mid-cap stocks have also beaten those of small-cap stocks during the trailing three-, five-, and 10-year periods, with lower volatility.

“Mid caps are a vital portion of the market, and investors who allocate only to large caps and small caps will lack pure beta exposure to the largest segment of US firms,” said SSgA. “What’s more, mid-cap stocks have delivered higher annualized returns than their large- and small-cap peers over the past 24 years—and these returns were achieved with reduced volatility relative to small-caps.”

Related: A Smart Beta Mid-Cap ETF Opportunity

MDY, which tracks the S&P MidCap 400 Index, allocates nearly a third of its combined weight to technology and financial services stocks. The industrial and consumer discretionary sectors combine for almost 28.60% of the fund's weight. Data suggest that by historical standards, the mid-cap P/E ration premium to large caps is currently low.

“Based on data since 1995, the median premium from a P/E perspective for mid-cap stocks relative to large-cap stocks is 13%,” said SSgA. “In other words, the P/E ratio of mid-cap companies is typically 13% higher than those of large caps. However, today that premium is just 7%, indicating they are trading cheaper than they have relative to large-caps over the last 22 years.”

For more information on mid-caps, visit our mid-cap category.