Midcap Funds: Worth Investing In Now?

Mid-cap stocks are an intriguing investment opportunity, given their high-return potential and riskiness. Mid-cap companies have a market capitalization of $2 billion to $10 billion and provide investors with growth opportunities in well-known companies. While mid-cap stocks have historically outperformed their larger and smaller peers, investors tend to be underexposed to them. In this article, we will explore the pros and cons of investing in mid-cap funds, the factors driving their growth, and whether now is a good time to consider adding them to your portfolio.

Mid-cap funds: pros and cons

Mid-cap funds are a compelling investment opportunity, often overlooked by investors. They offer a balance of growth and stability and are a great option for those looking to diversify their portfolios.

Pros

Mid-cap companies are defined by their market capitalization, which typically falls between $2 billion and $10 billion. They are an attractive investment option because they have:

• A proven business model: Mid-cap companies have already navigated the high-risk phases associated with startups and have a lower level of investment risk.
• Growth potential: These companies are well-positioned to leverage cheaper forms of financing to fuel their future growth.
• Historical outperformance: Historically, mid-cap stocks have outperformed small- and large-cap stocks over longer periods, offering higher absolute returns.
• Lower volatility: Mid-cap stocks have provided higher returns with less associated risk when compared to small-cap stocks.
• Diversification: Mid-cap stocks can add balance to an investment portfolio, providing both growth and stability.

Cons

Despite their advantages, there are some challenges and risks associated with investing in mid-cap funds:

• Less known: Mid-cap companies are less established than large-cap companies, and their products may be just starting to gain recognition. This means investors need to spend extra time on research and analysis.
• Management challenges: As mid-cap companies grow, their management styles may need to adapt to meet new demands from suppliers, investors, and employees, as well as competitive market forces.
• Risk of underperformance: While mid-cap stocks have historically outperformed in the long term, there is no guarantee that they will always outperform their larger or smaller counterparts in the short term.
• Volatility: Mid- and small-cap stocks tend to be more volatile, and investors need to be comfortable with the potential for extra volatility in their portfolios.

In conclusion, investing in mid-cap funds offers a compelling opportunity for those seeking growth and diversification. However, it is important to carefully consider the potential risks and challenges, including the need for thorough research and the possibility of higher volatility.

Historical performance

Mid-cap stocks have historically outperformed their larger and smaller peers with less volatility than small-caps. In any one-year rolling period since 2003, small-, mid-, and large-cap stocks have outperformed 33%, 26%, and 41% of the time, respectively. However, the longer investors hold mid-cap stocks, the more likely they are to outperform. Between 2003 and 2023, mid-caps outperformed small- and large-cap stocks 60% of the time with less associated risk.

In the long term, mid-caps have traditionally offered better growth than large-caps. Mid-cap stocks have a long history of outperforming their larger and smaller peers, spanning more than 40 years. From 1978 to 2024, a $10,000 investment in mid-sized companies would have grown to over $2.4 million compared to $1.6 million for large-cap stocks and $1.1 million for small-cap stocks.

When reviewing rolling five-year performance snapshots, which typically capture rising and falling stock market environments, mid-cap stocks have outperformed large caps 55% of the time since 1983. They also outperformed small caps 89% of the time during the same period. These observations include periods of negative investment returns.

Mid-cap stocks have generated higher absolute returns over a longer time frame and have provided these returns with less associated risk. Over the 20-year period ending September 30, 2023, investors in mid-caps experienced higher returns and lower risk relative to investors in small-caps. Additionally, while mid-caps had more risk than large-caps, investors were rewarded with higher returns over the same period.

In summary, mid-cap stocks have a strong historical performance record, outperforming their larger and smaller peers over both the short and long term. They offer a balance of growth and stability, making them an attractive investment option for those seeking to diversify their portfolios.

Risk and volatility

Mid-cap companies are typically defined as those with a market capitalization between $2 billion and $10 billion. They have already navigated the high-risk phases associated with startups and early market development, which can mean a lower level of investment risk for investors. Additionally, mid-cap companies may have more established business models, management teams, and customer bases compared to small-cap companies, leading to a perception of reduced risk.

However, it is important to note that mid-cap stocks can still be volatile and carry significant risks. These risks include macro risks, company-specific risks, and competitive risks. The performance of mid-cap stocks can be more sensitive to changes in economic conditions, and their underlying businesses can go through sharp ups and downs. As a result, mid-cap stocks may perform well during boom times but crash during downturns.

When considering investing in mid-cap funds, it is crucial to assess your risk tolerance and volatility tolerance. Mid-cap funds can provide diversification benefits and exposure to a different set of companies compared to large-cap or small-cap funds. However, the higher risk and volatility associated with mid-cap stocks mean that they may not be suitable for all investors.

In summary, while mid-cap funds offer the potential for higher returns, it is important to carefully evaluate your risk appetite and volatility tolerance before investing. Conducting thorough research and analysis, and potentially seeking advice from a financial professional, can help you make an informed decision about whether to invest in mid-cap funds.

Growth potential

Mid-cap stocks have a long history of outperforming their larger and smaller peers with less volatility than small-caps. Mid-cap stocks tend to offer investors long-term growth potential with a bit more stability than many small-cap stocks.

Mid-cap companies commonly have a market capitalization of $2 billion to $10 billion and provide investors with opportunities for growth in well-known companies. They have proven business models, capable management teams, and well-established customer bases and brands. They have grown from small-caps, but many still offer growth potential.

In any given 1-year rolling period since 2003, small-, mid-, and large-cap stocks have outperformed 33%, 26%, and 41% of the time, respectively. However, the longer mid-cap stocks are held, the more often they outperform. In fact, 60% of the time, mid-caps outperformed small- and large-cap stocks over any 10-year rolling period in the past 20 years.

While the large-cap sector led the way in terms of performance during the recent bull market—particularly in the technology area—over the long term, mid-caps have traditionally offered better growth than large-caps. Mid-cap stocks have a historical pattern of outperformance compared to large- and small-cap stocks. It becomes clear when analyzing rolling five-year performance snapshots, which typically capture rising and falling stock market environments.

As of June 2024, the constituents of the S&P 400 Index ranged from $1.26 billion to $20.87 billion. The mid-cap segment of the market is relatively underfollowed by the investing public. In many cases, investors are more interested in well-known large caps or the lucrativeness of up-and-coming small caps. However, mid-caps may provide investors with an opportunity for growth.

Investment strategies

Mid-cap funds are a good investment for those willing to accept the associated risks. Mid-cap companies can provide substantial long-term gains, but they are also quite volatile.

Mid-cap funds are a good match for investors with a moderate risk appetite, who are willing to invest long-term, and are happy to start with a small amount.

• Long-term investment horizon: Mid-cap funds are suitable for investors with a long-term investment horizon, typically 7 to 10 years. These companies are yet to become big, and they may take time to recover during a slowdown.
• Risk appetite: Mid-cap funds carry a higher risk than large-cap funds but also offer the potential for higher returns. Therefore, they are suitable for investors with a moderate to high-risk appetite.
• Volatility: Mid-cap funds can be volatile in the short to medium term. Investors need to be prepared for potential sharp drops in portfolio value.
• Diversification: Mid-cap funds can be a good choice for investors looking to diversify their portfolios. Mid-cap companies are well-known but not as established as large-cap companies, so they offer a balance of growth and stability.
• Research and analysis: Mid-cap companies are less known than large-cap companies, and their products may be just starting to gain recognition. This means investors need to spend extra time on research and analysis.
• Fund manager expertise: When selecting a mid-cap fund, it is important to consider the fund manager's competence, market understanding, investment strategy, and management style.
• Historical performance: Analyze the fund's previous performance across different market cycles to determine if it has consistently provided strong returns. However, remember that past performance does not guarantee future results.
• Expense ratio: Consider the expense ratio, which includes fees associated with fund management. Compare the cost ratios of different mid-cap funds to find one with affordable fees.
• Risk profile: Assess the fund's risk profile to ensure it matches your risk tolerance. Some mid-cap funds may be riskier than others, depending on their investment approach or sector specialization.
• Liquidity risk: Mid-cap equities may not be as widely traded as large-cap stocks, making it harder for investors to buy and sell shares. This can lead to wider bid-ask spreads and increased transaction costs.
• Market risk: Mid-cap companies may be more sensitive to market swings than large-cap firms, resulting in higher volatility. Mid-cap funds may suffer more significant losses during market downturns or economic uncertainty.
• Fees and charges: Mid-cap funds often charge higher fees than large-cap funds due to the additional research required to uncover undervalued companies. Carefully consider the expenses before investing.

Overall, mid-cap funds can be a good investment strategy for those with a long-term horizon, a moderate to high-risk appetite, and a willingness to accept volatility. They offer the potential for substantial long-term gains and can provide a balance of growth and stability in an investment portfolio.

Frequently asked questions