There's plenty of uncertainty out there in the markets these days. From slowing growth in key emerging markets like China and developed Europe's debt woes, to the various political issues here in the United States, uncertainty seems to be the only certain thing facing investors. Given this fact, finding ways to position one's portfolio can be a daunting task.
We all know that we need some allocation to stocks, especially if we have a long-term timeline; but large caps can lag in rising markets and smaller firms can be decimated if the global economy really turns sour. With all the ambiguity plaguing the global economy, both of these outcomes seem perfectly feasible. Perhaps the best equity position might lie somewhere in the middle.
The Market's Sweet Spot
For those investors looking for better growth opportunities than what large-cap stocks can offer, but minus the extreme volatility that plagues small-cap stocks, the often overlooked mid-cap space could be exactly what a portfolio needs. Defined as companies with market caps between $2 billion and $10 billion, they provide the right mixture of attributes for a slow- or fast-moving market.
First, mid-cap firms have plenty of advantages over their smaller sisters. Generally, these firms include seasoned management teams, as they are past the volatile start-up phase. Their slightly larger size also provides them with an easier time accessing the capital markets and in many cases, mid-cap companies are financially stable with steady cash flows. That financial stability allows them to create better IT infrastructures and broader distribution channels. That fiscal health also allows many mid caps to have the cash reserves necessary to bail out the firm in case of short-term problems.
That cash also leads to another mid-cap benefit versus its smaller peers: dividends. More than half of the firms within the S&P Midcap 400 (ARCA:MDY) pay dividends, and that broad index is currently offering an average 0.5% yield.
On the flip side, mid caps still offer plenty of growth opportunities as they mature, unlike large-cap giants such as Microsoft (Nasdaq:MSFT) or ExxonMobil (NYSE:XOM). Room for multiple expansions across new product lines, less overall bureaucracy and generally more entrepreneurial spirit help to drive mid-cap growth. That growth is also being driven by its larger sisters. The recent buildup of company cash over the past few years has produced a buyout binge not seen in years. Reluctant to hire or open new plants, many large caps have gone on acquisition sprees to spur growth. Mid-cap firms are often the targets of these buyouts.
"Goldilocks" Equals Outperformance
Being in the market's sweet spot certainly has its advantages when it comes to outperformance. Over the last 10 years - which included two recessions and resulting rebounds - mid caps have outperformed both their larger and smaller sisters by a wide margin. The Russell Midcap Index (ARCA:IWR) has produced a roughly 9.88% annual return in that timeframe. The broader Russell 3000 (ARCA:IWW) and small-cap weighted Russell 2000 (ARCA:IWM), however, have only produced returns of 7.01 and 9%, respectively.
Extending that timeline further out and mid caps continue to shine versus their smaller and larger peers. According to data provided by Fact Set, mid-cap stocks have "historically offered a favorable risk/reward tradeoff versus both large- and small-cap stocks."
Taking the Mid-Cap Plunge
Given the group's positive fast or slow moving market attributes, investors may want to give mid caps a strong position in their portfolios. There are plenty of household names in the sector, such as Green Mountain Coffee Roasters (Nasdaq:GMCR) or burger joint Wendy's (Nasdaq:WEN). However, the space may be best navigated through a broad basket approach. There are plenty of mutual funds and closed-ended funds that offer access, but exchange-traded funds or ETFs allow investors to bet on a wide swath of the firms under one ticker.
Both the SPDR S&P MidCap 400 and iShares Russell Midcap can provide investors exposure to the two most popular indexes and be used to instantly beef-up the portion of mid caps in one's portfolio. Add ETFs low expense ratios and intraday tradability, and you have a recipe for making sure your portfolio has coverage in both fast- and slow-going markets.
The Bottom Line
Given all the uncertainty facing the global economy, there's an equal chance for either a slow- or high-growth scenario. That means investors may want to add mid-cap stocks to their portfolios. Featuring the right amount of growth and stability, mid caps represent a great opportunity to play the current and future marketplace.
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