Mid Caps: An Opportune Time to Allocate to this Overlooked Asset Class?


Often overlooked, mid cap companies tend to be more stable and established than small caps but are also growing faster than large, more mature companies. Mid caps typically capture the stage in an enterprise life cycle characterized by both a proven business model and a significant runway for potential growth. These companies are defined by a market capitalization between $1 billion and $50 billion.

Relative to large caps, mid caps tend to be under-followed by Wall Street analysts, leaving greater variance in valuation estimates and room for active investment managers to find strong businesses at attractive prices.(1) Relative to small caps, mid caps tend to be more diversified businesses, with pricing power at both the input (raw materials, labor, etc) and product output levels, greater access to capital markets, and an ability to adapt to changing environments.

Mid caps lifecycle stages

Becoming more reliable and stable as they grow out of the young and rapid-growth small cap stage, mid caps are not as limited in their future growth prospects as large caps. Active managers can exploit market inefficiencies (price variations) in the fertile mid cap space to find the next large cap company at an attractive price.

What is considered “mid cap”?

Within the equity market universe, mid caps typically reside between the largest 200 companies and those with market caps below $1 billion. Because of the makeup of broad market, cap-weighted indices, there tends to be some overlap between large and mid, and mid and small. For instance, the Russell 1000® Index is designed to measure the top 1000 U.S. stocks; the bottom 800 stocks within this index make up the Russell Midcap Index. This does not mean the Russell Midcap Index has an 80% overlap with the Russell 1000®. Due to weighting by market capitalization, the largest 20% of stocks make up about 73% of the Russell 1000® Index.

Mid cap risk and return

When examining historical performance, the case for mid caps becomes even more compelling. Relative to other asset classes, mid caps have produced a higher average annual return and lower volatility. Over the last 25 years, the Russell Midcap Index returned 9.2% annually, compared to 7.9% for the S&P 500 (large cap), 8.0% for the Russell 1000 (large cap), and 7.4% for the Russell 2000 Index (small cap).

Over the same time period, the Sharpe Ratio for mid caps was 0.49%, compared to 0.45%, 0.45%, and 0.36% for the S&P 500, Russell 1000, and Russell 2000, respectively. Sharpe ratio measures risk-adjusted performance, calculated by comparing an investment’s return to that of a risk-free asset, such as a treasury bill or bond.

Mid cap performance following a recession or major market drawdown

Mid caps have shown an ability to emerge from significant downturns stronger than their large and small cap counterparts. Whether we have seen the bottom of this current market cycle or are headed to a market bottom, investors would be wise to analyze the performance of market segments through recoveries. Looking at the three years following the most recent market drawdowns, mid caps have outperformed large caps in each instance by an average of 3,285 basis points (bps) and small caps in two of the past three periods by an average of 1,322 bps. (2)

Mid caps recession returns

Mid caps in an asset allocation portfolio

This performance does not happen by chance. As demonstrated by the long-term risk-adjusted returns in relation to both large caps and small caps, as well as how mid caps have historically fared following significant market downturns, we believe mid caps have earned the right to be viewed as a stand-alone component in an investment portfolio. While every market cycle presents new and unique risks, investors should consider how mid caps fit into the economy, markets, and investment portfolios.

Qualities of mid caps

Nimbleness: While their business model tends to be more established and mature than smaller companies, it is less complex than large caps, giving them a greater ability to adapt to changing economic conditions.

Revenue: While large caps tend to have operations around the globe, mid caps typically derive most of their revenue from within the U.S. This helps these companies reduce the impact of international risk dynamics and currency fluctuations.

Valuation: Relative to large-caps, mid caps tend to be under-followed by Wall Street analysts, leaving greater variance in valuation estimates and room for active investment managers to find strong businesses at attractive prices.

Flexibility: The breadth of the mid cap universe provides opportunities for managers to reach into the large or small cap space without compromising the portfolio’s mid cap character.

About Madison Mid Cap

Madison’s Mid Cap Equity strategy is a concentrated portfolio of 25-40 mid cap stocks. To pursue the goal of superior risk-adjusted returns, the team conducts extensive research to identify high quality companies with sustainable competitive advantages, high returns on capital, durable growth, shareholder-oriented management, and strong balance sheets.

“Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC (“MAM”), and Madison Investment Advisors, LLC (“MIA”). MAM and MIA are registered as investment advisers with the U.S. Securities and Exchange Commission. Madison Funds are distributed by MFD Distributor, LLC. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer and is a member firm of the Financial Industry Regulatory Authority. The home office for each firm listed above is 550 Science Drive, Madison, WI 53711. Madison’s toll-free number is 800-767-0300.

Any performance data shown represents past performance. Past performance is no guarantee of future results.

Non-deposit investment products are not federally insured, involve investment risk, may lose value and are not obligations of, or guaranteed by, any financial institution. Investment returns and principal value will fluctuate.

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1 Source: FactSet
2 Drawdowns defined as a >19% decline in a calendar year for one or more major equity market index.

Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only, and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance.

Market Capitalization: the total dollar market value of a company’s outstanding shares of stock.

S&P 500® is an unmanaged index of large companies and is widely regarded as a standard for measuring large-cap and mid-cap U.S. stock-market performance. Results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index.

RUSSELL 1000®: Russell 1000® Index measures the performance of the 1,000 largest companies in the Russell 3000® Index, which represents approximately 89% of the total market capitalization of the Russell 3000 Index.

RUSSELL 2000®: Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 11% of the total market capitalization of the Russell 3000® Index. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group.

RUSSELL MIDCAP: Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000® Index, which represent approximately 35% of the total market capitalization of the Russell 1000® Index. As of the latest reconstitution, the average market capitalization was approximately $3.7 billion; the median market capitalization was approximately $2.9 billion.

Equity risk is the risk that securities held by the fund will fluctuate in value due to general market or economic conditions, perceptions regarding the industries in which the issuers of securities held by the strategy participate, and the particular circumstances and performance of particular companies whose securities the fund holds. In addition, while broad market measures of common stocks have historically generated higher average returns than fixed income securities, common stocks have also experienced significantly more volatility in those returns.

Investing in small, mid-size or emerging growth companies involves greater risks not associated with investing in more established companies, such as business risk, significant stock price fluctuations and illiquidity.

Basis points are a measurement of percentage points. One hundred basis points equals one percent.