Mid-Cap ETFs’ Moment

Many investors are happy to be moving on from the market volatility of 2022, which left a mere few good places to hide. Quite notably, however, exchange-traded funds (ETFs) drew impressive investor interest last year. Overall ETF usage marked a new annual record of over US$45 trillion in trading volume by the end of 2022—about US$10 trillion more than 2021’s haul.1 US ETF net inflows also reached nearly US$600 billion in 2022, with nearly US$38 billion in December.2

Following an extended winning streak for the large-cap US growth sector, big technology sector weakness led to much of the red seen in 2022, which may signal that a rotation is underway. In our analysis, while US small-cap stocks remain cheap, they may experience greater volatility and encounter lower liquidity amid interest rate hikes, especially should markets enter recessionary territory. Looking ahead, investors seeking consistent exposure to equities that may be able to better withstand turbulence than other asset classes may find it an ideal time to consider overlooked mid-cap stocks.

Why mid caps?

Hitting the so-called “sweet spot,” US mid caps—generally defined as companies with market capitalization between US$2 and US$10 billion—can offer faster growth prospects than large caps along with a lower risk profile than small caps.

Mid caps also have a history of outperformance in periods following financial recessions. From 2003 until 2006, mid caps outperformed large-cap stocks for three consecutive years following the recession of the early 2000s. Looking at annual total return from 2009, mid caps similarly outperformed over four out of the five years after the global financial crisis. Not only did they also perform well compared to the small-cap segment post-recession, but the cumulative returns from the start of 2000 through December 2022 show the Russell Midcap Index far outpaced the large-cap Russell 1000 Index with returns of 598% versus 334%.3

Another added benefit of this sometimes-forgotten segment is diversification. Mid caps tend to be less impacted by currency fluctuations and global downturns than large caps, which often include major corporations and multinationals that operate around the world.