Countless academic studies have found that stocks of small U.S. companies beat large-capitalization stocks over the long term. But a closer look at the data shows that mid caps are the market's real sweet spot.
The numbers are clear: Since 1926, U.S. mid caps have produced better returns than either large-cap stocks or small caps based on their Sharpe ratios, a widely accepted measure of risk-adjusted performance. Over that lengthy span, mid caps have returned an annualized 11.6%, compared with 9.6% for large caps and 12.1% for small caps. But small caps are 15% more volatile than mid caps--a high price to pay for one-half of one percentage point per year in additional gains.
Why should you care how stocks did on a risk-adjusted basis? Because the riskier the stocks you own, the deeper dives your investments will take in bear markets. And funds that suffer big losses are much harder to hold onto than funds with more-limited declines. "If you don't stay invested in a fund, you're not going to get its return," says
Rawson is intrigued by the superior risk-adjusted returns of mid-cap stocks. "Over that long a time period, since 1926, you'd expect that small caps would have generated the highest risk-adjusted returns," he says. "But mid caps have outperformed both small caps and large caps."
Mid caps have also outperformed large-company and small-company stocks lately. Over the past 10 years, mid caps have returned an annualized 9.6%, compared with 8.3% for small caps and 7.2% for large caps.
Rawson compiled the data for this article from the
Despite their superior performance over the past 10 years, mid caps aren't particularly expensive. The average price-earnings ratio of mid-cap stocks at the end of October was only slightly higher that it has been historically, according to data compiled by the
Not only are mid caps first-rate investments, but fewer analysts track mid caps than large caps. That gives skilled fund managers who focus on this slice of the market a better shot at beating mid-cap index funds than managers who dabble in the large-cap space.
Below are my four favorite mid cap funds. Based on the evidence, you might consider adding one to your portfolio.
Champlain Mid Cap (symbol CIPMX) is a sturdy workhorse that boasts particularly good relative returns in sour markets. In 2011, for instance, the fund gained 2.3%, compared with a 4.0% loss for the average mid-cap growth fund. (Growth funds look for faster-growing companies, while value funds emphasize stocks that are cheap based on measures such as P/Es.) Over the past five years, the fund returned an annualized 13.6%, an average of 1.6 percentage points per year better than the average mid-cap growth fund. (All returns are through
Lead manager
Fidelity Low-Priced Stock (FLPSX) defies gravity. Lead managerJoel Tillinghast has successfully steered this unusual fund for 26 years. Over the past 15 years, the fund returned an annualized 11.8%, putting it in the top 1% among mid-cap value funds. Over the past 12 months, the fund returned 4.6%, landing in the top 21% of its peers. The key criterion for inclusion in the fund is a share price that's no greater than
T. Rowe Price Diversified Midcap Growth (PRDMX) earned an annualized 9.2% over the past 10 years--an average of 1.3 percentage points per year more than the typical mid-cap growth fund. Comanagers Donald Peters and
Vanguard Mid Cap Index Investor (VIMSX) is a first-rate choice for investors who want to match the market. The fund tracks the CRSP U.S. Mid Cap Index; the average market cap of its holdings is
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Steven T. Goldberg is an investment adviser in the Washington, D.C. area and a contributing columnist for Kiplinger. .