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Middle-cap syndrome: often overlooked, but not to be underestimated

By: Catherine Yoshimoto, Sr. Index Product Manager

When evaluating the US equity market, we often find ourselves thinking in terms of a company’s relative size. There are mega-cap companies that the market perceives as providing stability and small-cap companies that are perceived to offer more potential for growth—but what about those in the middle? As a middle child myself, I felt an obligation to focus more on the mid-cap segment of the market—and I was pleasantly surprised at what I found.

As you can see below, the Sharpe ratio of the Russell Midcap Index measuring the mid-cap tier of the market has quietly exceeded that of the others—and over 20 years! This certainly grabbed my attention. What is it about this middle tier that has allowed it to outperform all other size tiers over such a long time horizon?

Perhaps this segment of the market benefits from having a mix of both the stability of large-caps and the growth opportunities of small-caps. This middle tier contains companies that have a proven history of success but still stand to benefit from a bit of growth as they transition out of small-cap and move towards becoming mega-cap companies.

Russell US Indexes Sharpe Ratio Comparison Over the Last 20 Years to July 31, 2016

Source:  FTSE Russell, data as of July 31, 2016. Past performance is no guarantee of future results. Please see the disclaimer for important legal disclosures.

Now that mid-caps have gotten our attention, it’s interesting to dissect this tier further into its growth and value styles. The Russell US Style Indexes were introduced in 1987 as benchmarks of growth and value investment styles.[1] A growth investor seeks companies that are correctly valued by the market but have potential for high future earnings growth. A value investor is a bargain hunter looking for undervalued companies that will correct themselves over time.

During the first, highly volatile, seven months of 2016, the Russell Midcap Value Index outperformed not only the Russell Midcap Growth Index but each of the growth and value indexes of its mega-cap (Russell Top 200 Index) and small-cap (Russell 2000 Index) counterparts. As you can see below, the value indexes across the board have been outperforming their corresponding growth indexes year-to-date. As I’ve discussed in an earlier blog, this pattern is consistent with the majority of past US presidential election years when uncertainty typically runs high.

Total Index Return Year-to-Date 7/31/2016

Source:  FTSE Russell, data as of July 31, 2016. Past performance is no guarantee of future results. Please see the disclaimer for important legal disclosures.

Given the prevailing market volatility and slow-growth environment in 2016, it would stand to reason that value stocks have outperformed. Sharp price declines followed by rebounds in a relatively short time frame have provided some value opportunities. And perhaps the lower profile nature of mid-cap companies means it is only knowledgeable investors who are in a position to react to changes in prices as most investors’ attention is typically diverted elsewhere.

My big takeaway from this analysis? Pay attention to that middle child; they are not to be underestimated!

For more information, visit the Russell US Style Indexes page.

 

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[1] For additional details on the Russell Style Index methodology, see the Construction and Methodology
 

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