U.S. mid-caps are an asset class that’s full of potential.
Large-capitalization companies generally start out small, moving from small-cap to mid-cap before potentially making it big. Investing in the mid-caps that are poised to become large-caps can give investors an opportunity to participate in significant potential growth. Of course, the key is to identify the most promising mid-caps.
This is the task for Jeff Mo, portfolio manager at Mawer Investment Management Ltd., subadvisor for the Manulife U.S. Mid Cap Equity Fund. He oversees a broadly diversified portfolio of potentially wealth-creating mid-caps with excellent management teams, which he assesses and determines can be bought at a discount to their intrinsic value.
“We are looking at the companies in the U.S. that aren’t the household names,” Mo explained in a recent Mawer podcast.[1] “These are companies that are not fully dominant or ready in their niche yet. These are companies that are certainly strong and have established competitive positions and we can analyze their competitive advantage. But, at the same time, they’re not so saturated in the market that the potential for growth and change is no longer there.”
U.S. opportunity
Canadians invested a record $82 billion[2] in U.S. securities between January and November 2021. They were likely attracted by the historical outperformance of U.S. equity markets – after all, over the past two decades the S&P 500 Index has averaged an annual compounded rate of return of 9.5%, beating the 8.0% return of the S&P/TSX Composite Index. The outperformance gap was even wider in 2020 (16.0% vs. 2.2%) and 2021 (27.0% vs. 22.0%).[3] But many Canadian investors are also aware of the risks of home country bias and realize that more than 97 per cent of global equity market capitalization is beyond our borders. And they watched the energy sector’s challenges in 2020 drag down the S&P/TSX Composite Index because of its overconcentration in resources.[4] So, your clients are primed to hear about how investing in U.S. equities may offer opportunities to potentially improve returns and enhance both geographic and industry diversification.
The mid-cap approach
U.S. mid-caps offer a compelling balance between U.S. small-caps’ high growth potential, higher volatility and higher failure rates and U.S. large-caps’ mature market positions, lower long-term volatility, and business longevity.
And, in the 20 years leading up to March 31, 2022, mid-caps (represented by the Russell Mid Cap Index†) generated a higher annualized return than either small-caps (represented by the Russell 2000 Index††) or large-caps (represented by the S&P 500 Index†††). According to data from Morningstar, mid-caps delivered 9.0% compared to 7.4% for small-caps and 7.9% for large-caps.[5]
Focusing on mid-caps also helps investors avoid overexposure to the large-cap technology stocks that tend to dominate U.S. indexes.
Jeff Mo puts it this way: “When we look at the mid-cap portfolio, this is a great way for investors to gain exposure to the U.S. and really get ‘American dream’ exposure without needing to have a 20 or 25 per cent weight in big tech stocks that are great companies but, at the same time, tend to trade in a block with each other.”
The Manulife U.S. Mid Cap Equity Fund, launched in March 2022, consists of a high-conviction collection of mid-caps ranging in size from just under US$1 billion to US$60 billion that were selected for their sustainable competitive advantage and with the benefit of Mawer’s expertise.
“We’re always trying to find the forty or so best companies that fit our investment philosophy in [the U.S. mid-cap] universe, [and] we think that we can really balance the portfolio by being stock pickers in such a rich universe of stocks,” Mo said.
Learn more about the Manulife U.S. Mid Cap Equity Fund here.
[1] ”The Art of Boring Podcast: Introducing the Mawer U.S. mid cap equity strategy, Episode 95,” Mawer Investment Management Ltd, September 2021.
[2] https://www.bnnbloomberg.ca/canadians-keep-flocking-to-foreign-investments-during-pandemic-1.1711165. January 21, 2022.
[3] Ibid.
[4] Ibid.
[5] Source: Morningstar, March 31, 2022. Data represented by the following indices: Russell 2000 Index TR CAD, Russell Mid Cap Index TR CAD; S&P 500 Index TR CAD.
† The Russell Midcap Index is a market capitalization-weighted index comprised of 800 publicly traded U.S. companies with market caps of between $2 and $10 billion. The 800 companies in the Russell Midcap Index are the 800 smallest of the 1,000 companies that comprise Russell 1000 Index.”
†† The term Russell 2000 Index refers to a stock market index that measures the performance of the 2,000 smaller companies included in the Russell 3000 Index
††† The S&P 500 Index, or Standard & Poor's 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria that the index includes.
5 Source: Morningstar, March 31, 2022. Data represented by the following indices: Russell 2000 Index TR CAD, Russell Mid Cap Index TR CAD; S&P 500 Index TR CAD.
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