“I see potential in investing in US mid-cap indices, they are expected to better withstand the changing market conditions expected in 2023,” says Dina Ting, CFA, head of global index-linked investing through ETFs at Franklin Templeton.
Ting explains that investing in mid-cap companies in the US – generally defined as companies with a market capitalization between $2 billion and $10 billion – can offer faster growth prospects than investing in large stocks, along with a lower risk profile than small companies.
She says many investors are happy to move on from the market volatility of 2022, which left few good places to hide. However, it seems that exchange-traded funds (ETFs) generated impressive interest among investors last year. The total use of certificates and ETFs marked a new annual record of over 45 trillion dollars in trading volume by the end of 2022 – about 10 trillion dollars more than the trading volume in 2021.
After a long streak of US growth sector success, weakness in the large tech sector has led to much of the declines we’ve seen in 2022, which may signal a rotation is underway. According to Ting, while US small-cap stocks remain cheap, they may experience more volatility and run into liquidity. Lower due to interest rate hikes, especially if the markets enter recession territory. Looking ahead, investors looking for consistent exposure to stocks that may better withstand turbulence may find this is an ideal time to consider mid-cap stocks.
The cumulative returns from the beginning of 2000 to December 2022 show that the Russell Midcap Index far outperformed the Russell 1000 Index with returns of 598% versus 334% returns for the Russell 1000 Index.
Mid-cap stocks have a history of outperforming in post-financial recession periods. From 2003 to 2006, mid-cap stocks outperformed large-cap stocks for three straight years after the recession of the early 2000s.
Mid-caps have outperformed in four of the five years since the 2008 global financial crisis. Looking at total annual returns since 2009, mid-caps have outperformed in four of the five years since the global financial crisis. Not only have they also performed well compared to the post-recession small-cap segment, but the cumulative returns from early 2000 through December 2022 show that the Russell Mid Cap Index far outperformed the Russell 1000 Index with returns of 598% versus 334% returns for the Russell 1000 Index.
Another advantage is diversity. Mid-sized organizations tend to be less affected by currency fluctuations and global downturns than large companies, which often include large corporations and multinational companies operating around the world. At the end of 2022, technology sector holdings accounted for 24% of the Russell 1000 index, including 13.4% of the index’s top 10 holdings. By contrast, technology sector holdings in the Russell Midcap Index accounted for only half of that at 12%, with technology representing just 1.5% of the top ten holdings.
Beyond market capitalization criteria, we believe that multifactor strategies can provide improved diversification with higher risk-adjusted returns and lower volatility than a traditional market capitalization-based index. In our opinion, a forward-looking, rules-based index design that analyzes exposure of individual stocks against a well-tested combination of factors – quality, value, momentum and low volatility – helps provide exposure to quality companies at a reasonable price and avoid value traps.
We believe that a strategic combination of these factors can result in a smoother return profile, which should appeal to investors as we enter another year with changing market conditions.
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