Don't Overlook Mid-Cap Stocks | American Century (2024)

Key Takeaways

Imagine developing an investment strategy and identifying an opportunity to improve performance potential without increasing your exposure to riskier small companies. Many of us would at least consider it. But interestingly, that doesn't appear to be the case for many investors when it comes to mid-capitalization (mid-cap) stocks.

Though mid-caps have a history of outperforming their large- and small-cap peers, most investors are underexposed to this category.¹ In this article, we will discuss why we consider mid-caps to be the stock market's sweet spot and how allocating to this space has the potential to improve stock portfolio returns without taking on the risk of increasing small-cap exposure.

Mid-Cap Stock Performance Has Been Compelling

Large household names and smaller businesses offering the alluring potential to get in on the ground floor often overshadow mid-sized companies. With market capitalizations between roughly $10 billion and $54 billion, we find that many successful mid-cap companies have proven business models, capable management teams and established customer bases and brands. They have grown from small-caps, but many still offer growth potential.

In our view, it's a mistake to overlook mid-caps in favor of the stock market's largest and smallest companies. Figure 1 shows the growth of hypothetical investments in large-, mid- and small-cap stocks since the 1978 inception of the Russell Midcap® Index. Mid-cap stocks would have generated more than twice the wealth of small-caps and approximately 72% more than large-caps. During those 45 years, a $10,000 investment in mid-sized companies would have grown to over $2.4 million compared to $1.6 million for large-cap stocks and $1.1 million for small-cap stocks.²

When reviewing investment performance, it's important to remember that investing involves risk, and the period studied included stretches of negative performance.

Figure 1 | Mid-Cap Stocks Would Have Generated Greater Wealth Than Large-Caps and Small-Caps

Hypothetical Growth of $10,000

^{Data from 12/31/1978 – 3/31/2024. Source: FactSet. Past performance is no guarantee of future results. This hypothetical situation contains assumptions that are intended for illustrative purposes only and are not representative of the performance of any security. There is no assurance similar results can be achieved, and this information should not be relied upon as a specific recommendation to buy or sell securities.}

Mid-Cap Stocks Have a Track Record of Outperformance

Mid-cap stocks have a historical pattern of outperformance compared to large- and small-cap stocks. It becomes clear when we analyze rolling five-year performance snapshots, which typically capture rising and falling stock market environments.

As shown in Figure 2, mid-cap stocks have outperformed large caps in 55% of rolling five-year periods since 1983. Mid-caps also outperformed small-caps 89% of the time during the same period. These rolling observations include periods of negative investment returns.

A closer look at the data reveals that mid-caps historically outperformed large-caps when the market favored smaller stocks. Similarly, they outperformed smaller stocks when investors preferred the stocks of larger companies.²

Figure 2 | Rolling Returns Demonstrate a History of Mid-Cap Outperformance

Mid-Caps vs. Large-Caps

Mid-Caps vs. Small-Caps

^{Data for both charts from 12/31/1978 – 3/31/2024. Source: FactSet. The charts depict rolling monthly observations of trailing five-year returns. Excess return refers to the difference in performance of the indexes we are comparing and can be expressed as a positive or negative number. Bars above the 0% line indicate the amount of mid-cap outperformance. Bars below the line indicate the amount of mid-cap underperformance. The performance period began on 12/31/1978, with the first five-year return observation on 12/31/1983. The Russell Midcap® Index represents mid-cap stock performance. The} Russell Top 200® Index ^{represents large caps, and the} Russell 2000® Index ^{represents small caps. The indices are not investment products available for purchase. Past performance is no guarantee of future results.}

Investors May Be Underexposed to Mid-Cap Stocks

Despite mid-cap stocks' track record, investors tend to have inadequate exposure to this portion of the equity market. Mid-caps account for 23% of the domestic equity universe. Yet the asset class represents only 10% of investors' domestic equity mutual fund assets, according to Morningstar, as of March 31, 2024.

A misperception of the Russell 1000® Index's composition may account for some of the underexposure. Because the index includes large-cap stocks (the top 200) and mid-cap stocks (the remaining 800), investors may believe their index fund or exchange-traded fund provides adequate mid-cap exposure.

In reality, larger companies have an oversized impact on the index's results. The 200 largest companies comprise 78% of the Russell 1000's weight, dwarfing the effect of the index's 800 mid-cap companies. What's more, the combined weight of just the six largest companies in the index is greater than all 800 mid-caps.

Faulty diversification strategies may be another reason for underexposure to mid-caps. When building their stock portfolios, investors may overweight the market's largest companies due to their defensive characteristics.

At the same time, they may seek to increase their portfolio's return potential by investing in the market's smallest and riskiest stocks. Such an approach bypasses the attractive risk and return potential of mid-caps.

Consider an Allocation to Mid-Caps for Your Diversified Investment Strategy

We think mid-caps represent a time-tested market sweet spot with a history of outperforming large- and small-cap stocks. Their performance and risk characteristics offer the potential to improve stock portfolio returns while reducing risk compared to small-caps.