After a tumultuous summer that included the Brexit vote and concerns about economic slowdown in Japan and China, many investors are worried about the health of the global economy. Though the U.S. economy is relatively strong, these events have caused investors to wonder, among other questions, whether their current investment strategy leaves them with too much exposure. In turn, advisers are looking for ways to give clients exposure to the market while also allowing them to sleep at night.
Enter mid-cap funds, which hold shares of companies that range from $2 billion in $10 billion in market cap. They are established businesses that are still developing, providing more growth potential than large-cap stocks coupled with less volatility than small-caps.
“Mid-caps offer a sweet spot between large- and small-cap stocks,” says Mark Hackett, senior research analyst for Nationwide. “Traditionally we have seen mid-caps outperform large-caps at this point in the economic cycle, but they haven’t yet. So we feel it’s an opportunistic moment to consider mid-caps now.”
With these indicators in mind, here are three reasons why advisers may want to consider adding mid-cap funds to clients’ portfolios:
Growth can mean greater returns
Mid-cap companies are typically still growing. They have moved past the risky small-cap stage where many companies fail and into the mid-cap range, which offers more stability. “They’ve already gone through the real danger stage and survived to tell about it. But they also aren’t mature, so they offer greater earnings growth potential” says Hackett. He notes that investors can generally expect midcaps to offer increased stability and continued strong growth, often backed by strong balance sheets and cash flow when compared with small caps.
Because mid-cap stocks haven’t reached their traditional performance levels at this point in the economic cycle, they have been selling at a slight discount. Cheaper prices give investors the chance to take advantage of the growth potential they offer. “Over the next five years, we expect mid-caps to grow earnings faster than large-caps,” says Hackett.
What’s more, this opportunity comes at an advantageous moment in the economic cycle when revenues and earnings typically become harder to achieve.
Dividends may be available
In addition to their growth potential, many mid-cap stocks offer dividends. Large-cap companies frequently offer dividends as well, but mid-cap stocks’ dividends may continue to grow larger as the companies grow.
Dividends are useful for retirees and other investors who are seeking income: They offer both income and the potential for stocks’ greater returns relative to bonds.
Mid-caps offer growth and less volatility
Mid-cap stocks tend to be less volatile than small caps, while offering more growth than large caps. That said, they do tend to be more volatile than large-cap stocks, which typically provide stability based on a track record of strong earnings.
While it’s not uncommon for investors to hold portfolios comprising only large-cap stocks, Hackett recommends using mid-cap stocks to add diversification and mitigate risk. “A portfolio of mid-cap and large-cap stocks that is rebalanced regularly provides more growth potential and should have less volatility than either group individually. Of course, each investor will have different financial goals and risk tolerance, thus mid-cap exposure may not be appropriate for everyone” he says.
Mutual funds that invest primarily in mid-cap stocks further offer investors the ability to diversify across a range of sectors and geographical regions. Portfolio managers choose stocks with diversification and risk in mind, providing investors a method to mitigate risk efficiently.
Disclosures
Investing involved market risk including possible loss of principal. There is no guarantee that fund objectives will be met.
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