In 2023, the outperformance of large-cap stocks and the possible comeback of small-caps have captured investor attention. But there’s a sector with great potential that sits in between them: mid-cap stocks.
FTSE Russell defines mid-caps as the smallest 800 companies in the Russell 1000 Index. The Russell Midcap Index has risen 6.9 percent year-to-date, less than half the 14.5 percent gained by the Russell 1000 Index. But despite the recent underperformance, mid-cap stocks have outperformed their mega-cap and small-cap peers over the period from 1979 to 2023, and they have the potential to outperform again over the next few years, according to $6 billion asset manager NFJ Investment Group.
“The mid-cap space is a fascinating area,” said John Mowrey, chief investment officer at NFJ. “What’s really cool about the mid-cap space is that they have higher returns than the large-caps and grow faster, with lower volatility than the small-cap arena. They’ve often been referred to as a ‘sweet spot,’ because they represent a hybrid of larger-cap stocks with stability and small-cap stocks with growth potential.”
Compared to their smaller peers, mid-cap companies are having an easier time raising capital from investors in the current environment, Mowrey added. That makes mid-sized companies good acquisition targets for large-caps.
He also noted that investors are often less exposed to mid-cap stocks than they may think. “In general, there’s a perception that investors are getting exposure to the mid-cap space via their large-cap allocation and small-cap allocation, but I can assure you that they are not,” Mowrey said. “Investors are generally biased toward the top 200 in their large-cap portfolios.”
Mid-cap value stocks are especially attractive in the current environment, according to Mowrey. Based on NFJ’s data, when large-cap growth stocks outperform mid-cap value stocks, that outperformance tends to be followed by a reversal in the trend. Over the past 30 years, there have been 17 instances in which the Nasdaq Index beat the Russell Midcap Value Index by 15 percent or more. In 88 percent of these cases, the mid-cap value index subsequently outperformed the Nasdaq index by an average of 16 percent annually over the next three years.
The Nasdaq Index has gained 31.8 percent year-to-date. Investors “would be better advised to be buying mid-cap value at this stage, because those names typically play catch-up,” Mowrey said. “Money will flow from one arena to the other . . . If you just have a small amount of rebalancing out of large growth into those smaller names to take advantage of the valuation discounts, that is a material amount of money that can roll into those smaller market cap names.”
