By Christopher Gannatti
We frequently discuss allocations that focus on large caps, small caps and all sorts of different factor exposures. Considering the persistence of their outperformance, we don't tend to hear enough about mid-caps.
Size Spectrum Analysis for Standard & Poor's Size Cuts
To define that persistence of outperformance, we looked at rolling periods of average annual returns.
Was There Any Consistency of Leadership Across Large Caps, Mid-Caps or Small Caps?
For definitions of indexes in the chart, visit our glossary.
- The S&P analysis indicated an advantage to the S&P MidCap 400 Index over the rolling 5-, 7- and 10-year periods. The longer the horizon, the greater the apparent persistence of this result.
What Is a Mid-Cap, Anyway?
There are no universally accepted definitions for large caps, mid-caps or small caps. WisdomTree's view is that stocks with market capitalizations below $2 billion constitute small caps, while stocks between $2 billion and $10 billion constitute mid-caps and stocks above $10 billion constitute large caps. We recently published a similar analysis for small-cap indexes.
How Different Are Commonly Followed U.S. Mid-Cap Indexes?
Weighted Average Market Capitalization: This is an important metric to consider, in that it combines the actual market capitalization size of the firms with the weighting mechanism of the indexes. The WisdomTree MidCap Earnings Index is weighted by earnings, whereas the WisdomTree MidCap Dividend Index is weighted by dividends. Stocks that are 1) included and then 2) weighted more highly would have the greatest influence.
WisdomTree MidCap Earnings Index Was the Smallest Among Mid-Caps: In terms of weighted average market capitalization, the WisdomTree MidCap Earnings Index was the smallest, at approximately $4.2 billion.
WisdomTree & S&P MidCap 400 Indexes: It's clear to us that the WisdomTree Indexes and the S&P MidCap 400 indexes shown in this chart all generally find themselves in that "between $2 billion and $10 billion" category. This is distinctly different than the MSCI and CRSP indexes-notable in that the CRSP indexes have weighted average market capitalizations approaching the $13 billion to $14 billion range.
Does Size Exposure Matter in Mid-Caps?
35% Spread in Cumulative Performance: What this 35% really tells us is not which of the mid-cap indexes shown will outperform over the next six years-as that is impossible to know today-but rather that the selection of the mid-cap index is enormously important. All of these indexes have "mid-cap" in their name, but as is clearly shown, performance was quite different.
Measuring Exposure to the Asset Class: In our experience, clients tend to put a lot of work into determining their asset allocation frameworks. If mid-cap equities in the U.S. are decided upon, it's important to select an exposure that actually generates that return experience. It's interesting that the CRSP U.S. Mid Cap Index had a .90 correlation of monthly returns to the S&P MidCap 400 Index over this period-both indexes are market capitalization-weighted and both seek to generate broad exposure to U.S. mid-caps. The WisdomTree MidCap Dividend Index, which includes solely mid-cap dividend payers, had a significantly higher correlation with this important benchmark, measured at .96 over this period.
WisdomTree's Indexes Hit 10 Years of Live History
If people asked us what our strongest mid-cap strategy would be if the corporate tax reform proposed by President Trump passes in some version, we would cite the WisdomTree MidCap Earnings Index. This Index has 10 years of live calculation and includes only profitable companies-in other words, the ones that would benefit from a reduction in taxes as opposed to those with negative earnings. It also addresses one of the key challenges in the market place today-that many feel the market is selling at high valuations-This Index has a price-to-earnings (P/E) ratio today of 17-18x that could see a reduction to range of 14-15x under a corporate tax reduction scenario. Why the reduction? Tax cuts would lead to earnings growth.
The WisdomTree MidCap Dividend Index also has been a steady generator of strong returns for almost 11 years. In our opinion, it has been a "category creator," fulfilling an income-generating need in a low interest rate environment within mid-cap stocks. Prior to this strategy's existence, dividends were thought to be a large-cap equity phenomenon.
Christopher Gannatti, Associate Director of Research
Christopher Gannatti began at WisdomTree as a Research Analyst in December 2010, working directly with Jeremy Schwartz, CFA®, Director of Research. He is involved in creating and communicating WisdomTree's thoughts on the markets, as well as analyzing existing strategies and developing new approaches. Christopher came to WisdomTree from Lord Abbett, where he worked for four and a half years as a Regional Consultant.