Midcap ETFs’ Overlooked Strength
If you’re the middle child, you know this well: It's easy to get lost in the shuffle.
Lacking the sheer size and flair of large cap companies, and without the promise of outsized growth potential and the appeal that small caps offer, midcap stocks often find themselves in that exact position: struggling to attract attention.
And yet, this part of the equity universe has offered so much to investors over the years.
A recent look into this segment from State Street Global Advisors—led by the firm’s head of research Matt Bartolini—found, somewhat surprisingly, that midcap stocks (as measured by the S&P 400) have either faced smaller declines during market trouble relative to their counterparts, or have recovered faster from losses in the aftermath.
Consider these findings from the research:
1997: The Asian financial crisis pressured markets around the globe. Midcaps led the recovery, with the S&P 400 climbing back to precrisis levels five times faster than small caps.
2000: The dot-com bubble burst. The S&P 400 recovered four times faster than the S&P 500.
2008: The financial crisis hit markets. The S&P 400 recovered two times faster than the S&P 500 and two months earlier than small caps.
Why does this universe of S&P 400 stocks led by names such as Etsy (ETSY), info-tech company Teradyne (TER) and FactSet Research (FDS) show such resilience?
“[Midcaps] have this flexibility and versatility, but also the strength to withstand being pushed around a bit,” Bartolini says. “Historically, over the last 25 years, midcap fundamentals have been strong—lower levels of debt relative to small caps, higher earnings growth than large caps. That results in a balanced and disciplined profile with some durability and strength, but also the aspects of growth.”
2020 Another Great Example
So far in 2020, the year of the global pandemic, midcaps have again delivered leadership in the recovery.
Since the March 23 U.S. stock market low, midcap stocks (as measured by the SPDR S&P Midcap 400 ETF Trust (MDY)) have led the way higher relative to the large cap SPDR S&P 500 ETF Trust (SPY) and the small cap SPDR Portfolio S&P 600 Small Cap ETF (SPSM):
There are today more than 30 U.S. midcap ETFs on the market. MDY is among the largest—the fourth largest, in fact—with $15.4 billion in total assets. This fund is a 25-year-old veteran with massive traction, and unmatched daily liquidity, trading some $400 million on average a day at $0.02 bid/ask spreads.
But MDY is not the segment leader in terms of assets. The iShares Core S&P Mid-Cap ETF (IJH) has long surpassed it, offering identical exposure to MDY (they both track the S&P MidCap 400 Index) but costing only about one-fifth of what MDY charges—0.05% versus 0.23% in fees. The fund today has a massive $46 billion in total assets.
Midcap ETFs are—like most everything else in the ETF world—not created equal. That holds true even among your broadest, most vanilla fare.
Case in point is the third largest midcap ETF, the iShares Russell Mid-Cao ETF (IWR). The fund tracks a different benchmark than MDY and IJH, the Russell Midcap Index. Top holdings are different: Lululemon, Xcel and DocuSign. But the most important difference relative to the S&P 400-linked strategies is in the index methodology. In the case of IWR, the benchmark holds the 800 smallest stocks found in the Russell 1000. IWR, which has $21 billion in assets, has a portfolio that’s twice as big as MDY’s and IJH’s.
IWR also tilts larger than MDY and IJH. Again, by design. FTSE Russell, during its most recent index rebalance in June, noted that while market capitalzation of the Russell 3000 (total market) hadn't changed much year-on-year, the top 10 companies in the U.S. had grown their market cap by 23%. The smallest companies, on the other hand, got smaller, and the broader index saw its first small cap stock drop below $100 million in market cap in a decade.
That widening gap between the big and the small pushed IWR's weighted average market cap to around $15.5 billion. That's roughly three times the average market cap of companies found in the S&P 400. (MDY has a weighted average market cap of only $5.5 billion. It tilts much, much smaller.)
If midcap as a size isn't an uniform descriptor, consider that when you compare the Russell-linked IWR to the S&P-linked IJH (or MDY), you also see that the overlap between these midcap approaches is surprisingly low—they only agree on 16.4% of companies, according to ETF Action data.
Companies like Southwest Airlines (LUV), Herbalife (HLF), D.R. Horton (DHI) and Tyson Foods (TSN) are only found in one of these portfolios.
Source: ETF Action
Consider The Overlap
It’s a similar story with the second largest midcap ETF, and one of the cheapest, at 0.04% fee, the Vanguard Mid-Cap ETF (VO). The fund, which has nearly $35 billion in assets, tracks the CRSP U.S. Mid Cap Index.
Of these big ETFs, VO offers the narrowest portfolio, with 355 stocks versus 400 for MDY and IJH, and 800 for IWR. Difference in benchmarks, again, matters here. According to CRSP, the index underlying VO looks to own a specific slice of the overall market--the companies that fall somewhere between 75% and 85% of the total market capitalization. The largest company in that slice has about $38 billion in market cap, putting the weighted average market cap of VO's portfolio above its top competitors, around $19 billion. (The top-end of S&P 400 range is under $9 billion, by comparison, according to S&P Dow Jones.)
The overlap between VO and the S&P 400-linked counterparts is minimal—these index providers agree only on 12 companies out of the midcap universe. VO and IWR share more common ground, but even then overlap sits around 57% .
Source: ETF Action
12 Names
In the end, this type of analysis tells us, first, that there seems to be no unanimously-agreed-upon market cap range of what a midcap stock is. These four massive ETFs agreed only on 12 names. Who knew there could be this much “disagreement” on what company falls in the midcap tier?
It also tells us that, you can never assume a broad vanilla midcap ETF will give you access to a stock you think is midcap. If you want to own, say, DocuSign and D.R. Horton in your midcap sleeve, due diligence is imperative. (You can find what ETFs hold any given stock in our ETF Stock Finder Tool).
Strong Performance
It’s also noteworthy that it’s the S&P 400 (MDY and IJH) that has delivered the strongest performance since the market low this March. The companies in that index have almost all gone through the earnings cycle and some 75% of them beat earnings-per-share estimates by an average of 40%, ETF Action data shows. That's quite the muscle.
Charts courtesy of StockCharts.com
Fees Matter
The takeaway? Midcaps are, as State Street put it, resilient. And 2020 has offered them another opportunity to show that.
But the universe of midcap stocks can be sliced and diced in many ways as three major index providers have shown us, and those differences lead to different ETFs and different results.
Perhaps unsurprisingly, investor demand in this space tilts heavily toward the lowest cost funds. So far in this recovery period, VO has picked about $3 billion in net creations. The fund has an expense ratio of only $4 per $10,000 invested. MDY, IJH and IWR have all faced net redemptions from March 23-to-date to the tune of about $4 billion in combined assets.
For more information on what U.S. midcap ETFs are available to you, check out our ETF Finder, and select Asset Class: Equity; Segment: Equity: U.S.-Mid Cap (results here) or check out Mid Cap ETF Channel.
Contact Cinthia Murphy at cmurphy@etf.com
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