Mid-Caps: Quietly Beating The Market For 25 Years

by: Bottom Fisher Ideas


Small caps are widely known for their persistent excess returns.

Mid caps have been quietly outperforming for the past 25 years.

There are plausible explanations for excess returns by mid caps, but they are difficult to prove.

There is some evidence that mid cap stocks should continue to do well.

Investment Thesis

Despite the reputation of small cap stocks for excess returns, mid caps have been beating both large caps and small caps for 25 years. It's not entirely clear why this has been the case, but there is some evidence that mid cap stocks are less covered by analysts, under-owned by investors, and will continue to perform well going forward. Investors should make sure they are sufficiently invested in mid cap stocks.

Small Cap Performance

A great deal is made of the outperformance of small cap stocks. It is featured in textbooks and it is the frequent focus of academic research. One of the reasons that it is so well known is because it is both persistent and it fits nicely with modern economic theory. In a world of efficient markets, as the risk of a particular investment increases, so must the expected return to compensate the investor for the additional risk. Since small caps are riskier than large cap stocks, the consistent excess return makes perfect sense.

Small cap outperformance has become such a given that small cap stocks have a strong following among individual investors and it is one of the factors in some smart beta strategies that are designed to beat the market.

Mid Cap Performance

While doing research for an article on a largely uncovered stock in the mid cap space, I was surprised to learn that mid cap stocks have been quietly outperforming for decades. Numerous white papers and articles have been written about mid cap performance in the past several years, but they rarely get much buzz. A recent run of great performance by large cap tech stocks probably hasn't helped them gain attention.

^MID Chart

^MID data by YCharts

A brief glance at the results so far this year show large caps beating mid caps and small caps handily. But how have they performed longer term? I decided that I wanted to see for myself rather than trust some possibly stale analysis by brokerages and investment management firms who might be pushing their own mid cap ETFs or funds.

The S&P 400 index is the most popular mid cap index, so that is what I decided to look at. Its not as dominant of an index as the S&P 500 is for large caps or the Russell 2000 is for small caps, but it would have to do. Since the S&P 400 was created in June of 1991, 1992 was where I would begin, which gives us a nice 25 year window of results to examine. I chose to look at total return (which includes dividend reinvestment), because that is what really matters to an investor. Here is what I found:

Total Returns
Year S&P 500 S&P 400 Russell 2000
1992 7.62% 11.91% 18.41%
1993 10.08% 13.95% 18.88%
1994 1.32% -3.58% -1.82%
1995 37.58% 30.95% 28.45%
1996 22.96% 19.20% 16.49%
1997 33.36% 32.25% 22.36%
1998 28.58% 19.12% -2.55%
1999 21.04% 14.72% 21.26%
2000 -9.10% 17.51% -3.02%
2001 -11.89% -0.60% 2.49%
2002 -22.10% -14.51% -20.48%
2003 28.68% 35.62% 47.25%
2004 10.88% 16.48% 18.33%
2005 4.91% 12.56% 4.55%
2006 15.79% 10.32% 18.37%
2007 5.49% 7.98% -1.57%
2008 -37.00% -36.23% -33.79%
2009 26.46% 37.38% 27.17%
2010 15.06% 26.64% 26.85%
2011 2.11% -1.73% -4.18%
2012 16.00% 17.88% 16.35%
2013 32.39% 33.50% 38.82%
2014 13.69% 9.77% 4.89%
2015 1.38% -2.18% -4.41%
2016 11.96% 20.74% 21.31%
High 37.58% 37.38% 47.25%
Low -37.00% -36.23% -33.79%
Average 10.69% 13.19% 11.22%
Median 11.96% 14.72% 16.49%

Source: Bottom Fisher Ideas

Sure enough, the average return of the S&P 400 since its inception has been 13.19%, beating the average returns of 11.22% for small caps and 10.69% for large caps during that same time period. If you invested $1 at the start of 1992, it would have become $16.32 in the S&P 400, $10.09 in the Russell 2000, and $8.92 in the S&P 500. That is pretty impressive.

Still, the Russell 2000 had a higher median return, the highest high and the highest low. Not only that, but it had the best performance in 11 of the 25 years, compared to the S&P 500 with 8 years of best returns and the S&P 400 with 6 years of best returns. Perhaps a few years of outsize gains by the S&P 400 have skewed things in its favor.

I decided to dig a bit further and look at the rolling 5 year and 10 year returns during these 25 years. If you examine the 5 year rolling returns, the S&P 400 performed best in 14 of the 21 periods, compared to 4 periods with best returns by the S&P 500 and 3 periods with best returns by the Russell 2000. If you examine the 10 year rolling returns, the S&P 400 performed best in all 16 periods.

10 Year Returns
Years S&P 500 S&P 400 Russell 2000
1992-2001 238% 305% 197%
1993-2002 144% 209% 100%
1994-2003 186% 268% 147%
1995-2004 213% 345% 198%
1996-2005 138% 283% 143%
1997-2006 124% 254% 146%
1998-2007 78% 189% 98%
1999-2008 -13% 55% 35%
2000-2009 -9% 85% 41%
2001-2010 15% 100% 85%
2002-2011 33% 97% 73%
2003-2012 99% 172% 153%
2004-2013 104% 168% 138%
2005-2014 109% 153% 111%
2006-2015 102% 119% 93%
2007-2016 96% 140% 98%

Source: Bottom Fisher Ideas

Even in the so-called lost decades for the S&P 500 ending in 2008 and 2009, the S&P 400 and to a lesser extent the Russell 2000 both posted significant gains.

Possible Explanations

How can this be? On the surface, it doesn't make much sense. While one could argue that mid cap stocks are riskier than large cap stocks and thus deserve the excess returns, how can one explain their superior performance to small caps?

A fairly recent white paper by Hennessy Funds published in 2016 argues that investors are chronically underweight mid caps. They also argue that the fundamentals of mid caps are good. Namely, that they have similar growth to small cap stocks, less risk, and greater access to capital markets.

In a 2015 article on Morningstar, it is noted that this mid cap performance gap is not exclusive to the US, it is also evident in the UK and Europe. The author points to the high level of merger and acquisition activity in the mid cap space as a cause. This M&A activity is unlocking value, contributing to excess returns.

Both of them argue that there is low analyst coverage of mid caps. Hennessy points out that this can lead to opportunities to invest in individual stocks, as there are more stocks that are incorrectly priced. Morningstar posits that the lack of research on the stocks leads to more earnings beats and increased returns across the board.

All of these explanations are plausible, but they are difficult to prove.

Will Mid Cap Excess Returns Persist?

Far more important than what has happened for the past 25 years is what is going to happen for the next 25. That is the key question.

One could certainly argue that mid cap stocks have gotten lucky and that there will be a reversion to the mean. After all, excess returns by mid cap stocks defy some economic theories. Perhaps the past 25 years has had especially favorable conditions for mid caps and the next 25 years won't have those same conditions. A certain amount of caution is warranted.

That said, there is something to the argument that there is low coverage by analysts and low ownership by retail investors. An article that I recently wrote was about a mid cap stock that is dominant in its industry, has a wide moat, high M&A activity and strong revenue growth, and yet has hardly been mentioned on Seeking Alpha in years. Compare that with multiple articles per day on some large cap stocks, and the disparity becomes clear.

There is anecdotal evidence that mid cap ownership is increasing and will continue to do so, slowly, through changes in index investing. For many years, S&P 500 index funds were the beginning and the end of index investing, whether it was the Fidelity Spartan 500 Index Fund (MUTF:FUSEX) or the SPDR S&P 500 ETF (NYSEARCA:SPY). Not only is more and more money pouring into index funds and ETFs, but they are finding their way to a greater variety of products beyond just the S&P 500. As more money ends up in index funds that track the total stock market instead of S&P 500 index, for instance, it should increase investors' exposure to mid cap stocks as a side effect and help propel mid cap stocks to additional gains.

How to Capitalize

The previous 25 years of returns are a good argument for increasing your exposure to mid cap stocks. In the past, I have been agnostic about capitalization, trying to match my investments to the capitalization of the stock market. But this research has caused me to reconsider. At the very least, investors should make sure they are not underweight mid cap stocks.

The three most liquid mid cap ETFs are also thankfully the ones with the lowest expense ratios.

  • The Schwab US Mid-Cap ETF (NYSEARCA:SCHM) comes in with the lowest expenses at 0.05%, but is also the least liquid of the top three. It tracks the Dow Jones US Mid Cap index and has 523 total holdings.
  • The Vanguard Mid-Cap ETF (NYSEARCA:VO) has expenses of 0.06% and slightly more liquidity. It tracks the CSRP US Mid Cap index and contains 348 holdings.
  • The iShares Core S&P Mid-Cap ETF (NYSEARCA:IJH) is the most liquid by far and has expenses of 0.07%. It tracks the S&P 400 Mid Cap index and owns all 400 stocks.

Any of the three ETFs are reasonable options for increasing your exposure to mid caps, as are a number of index and active mutual funds.

While a portion of my portfolio is in total stock market index funds, I prefer to focus on individual stocks. The lack of analyst coverage and low ownership by retail investors should lead to greater opportunity for stock pickers. While I haven't previously been focused on mid caps specifically, I will be looking for more compelling ones to add to Jones Lang LaSalle (NYSE:JLL) and New York Community Bancorp (NYSE:NYCB) that are already in my portfolio.


While large cap and small cap stocks get all the attention, mid cap stocks have been quietly beating the broader market for 25 years. Its not a sure thing that this effect will persist, but it makes a strong case for being overweight or at least equal weight mid caps. I'm going to keep my eyes open for opportunities to invest in quality mid cap stocks.

Disclosure: I am/we are long JLL, NYCB.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.