{"id":59555,"date":"2023-09-11T10:34:52","date_gmt":"2023-09-11T14:34:52","guid":{"rendered":"https:\/\/ifintechworld.com\/news\/mid-cap-stocks-not-too-hot-not-too-cold-just-right-for-investors\/"},"modified":"2023-09-11T10:35:02","modified_gmt":"2023-09-11T14:35:02","slug":"mid-cap-stocks-not-too-hot-not-too-cold-just-right-for-investors","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=59555","title":{"rendered":"Mid-Cap Stocks: Not Too Hot, Not Too Cold, Just Right For Investors"},"content":{"rendered":"
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Academic research has long-ago identified the size effect: A tendency of firms with small market capitalizations to outperform those will higher market capitalizations over time. An early paper that made this point is Banz (1981) and the idea was popularized in the academic and practitioner factor literatures by the Fama-French <\/span>3-factor and <\/span>5-factor models.<\/span><\/p>\n

The general empirical approach to testing the size effect is to sort portfolios of stocks into decile bins based on firms’ historical market capitalizations (the smallest 10% go into bin 1, the next 10% go into bin 2, and so on, until the largest 10% go into bin 10). Then the returns of the 10 size-sorted portfolios are tracked over time. The latter task is made far easier by the rich data repository Ken French makes freely available on his Dartmouth website.<\/span><\/p>\n

Using his data on size-sorted decile portfolios, and starting our analysis in 1963 (the usual starting point for factor-strategy analysis because the fundamental stock-level data needed to construct these strategies began in 1962), we find that over the last 60 years, small cap stocks did indeed outperform large caps – exactly in line with the size effect – as small caps (Lo 10) earned 11.2% per year while the largest stocks (Hi 10) earned 10%. Interestingly, the best-performing group of stocks since the 1960s were midcaps (middle capitalization stocks), as the 5th decile portfolio (Dec 5) was up 12.3% per year.<\/p>\n

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Ken French website, QuantStreet<\/p>\n<\/figcaption><\/figure>\n<\/p>\n

These small differences in annual returns translate to extremely large differences in total return outcomes. Over a 60-year horizon, compounded annualized growth rates (CAGRs) of 10%, 11.2%, and 12.3% mean an initial $1 investment would, after 60 years, grow to $304, $584, and $1,054 dollars, respectively.<\/p>\n

However, zooming into the more recent past – in particular the time period after the 2008-2009 Global Financial Crisis – the size effect reverses. The smallest decile of stocks was up 5.2% per year over the last 16.5 years, while the largest decile was up 9.8%, almost double the performance of the smallest capitalization stocks. Interestingly, the midcaps again feature near the top of the performance list, with the 6th decile (Dec 6) registering a 9.9% annual compounded growth rate.<\/p>\n

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Ken French website, QuantStreet<\/p>\n<\/figcaption><\/figure>\n<\/p>\n

Looking across time periods<\/h2>\n

To better understand the time variation in size-related performance, we subdivide our data into 8 equal sized intervals, starting from July 1926 until today. Each subplot in the figure below shows the performance of the size-sorted decile buckets in each subperiod. For example, in the 1926-1937 subperiod, the small-stock effect worked as advertised: small capitalization stocks returns close to 14% per year over the 10-year period, while large caps returns around 7%. But looking at the most recent subperiod, from 2010-2023, the effect reversed, with large caps returns close to 14% and small caps returning just over 8%. While, with some exceptions, midcaps are not the winners in any subperiod, their returns tend to fluctuate less over time than those of the smallest and largest companies, which oscillate from the best to the worst performing subgroups and then back again. Midcaps just chug along at a steady pace.<\/p>\n

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Ken French website, QuantStreet<\/p>\n<\/figcaption><\/figure>\n<\/p>\n

The next chart shows that part of the variation in average returns may be due to variation in realized volatility of the size-sorted stock decile portfolios. Each subplot shows the annualized volatility of each decile bin in the above subperiods. In the early subperiods, small stocks, in addition to outperforming large ones, tended to be considerably more volatile. But in other subperiods, like 1985-1998, the relationship flips and large caps become more volatile. Interestingly this subperiod was one where large caps outperformed small caps. Perhaps, then, the return differentials between the different size deciles arise from investors being compensated for owning more volatile stocks.<\/p>\n

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Source: Ken French website, QuantStreet<\/p>\n<\/figcaption><\/figure>\n<\/p>\n

If average returns are, indeed, compensation for additional return volatility, then the average return to realized volatility ratios may not exhibit the same patterns seen in average returns and realized volatilities, and may be less dependent on size decile. The next figure shows the Sharpe ratios for the size deciles, across the different subperiods (Sharpe ratios are defined as the average excess return, i.e., return above the riskless interest rate, divided by historical volatility of excess returns). But the size patterns do not disappear. In some subperiods small caps offer better return-risk trade-offs, and in other subperiods large caps are superior. The Sharpe ratio patterns across time periods mirror the patterns seen in average returns. Midcaps are, again, more stable than either the small or large caps, as their Sharpe ratios exhibit considerably lower variation over time.<\/p>\n

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Source: Ken French website, QuantStreet<\/p>\n<\/figcaption><\/figure>\n<\/p>\n

Getting midcap exposure<\/h2>\n

To summarize:<\/p>\n