Over the long term, mid-cap stocks tend to outperform small and large caps.
As such, “we see mid caps as a sweet spot of the market,” says David Hollond, CIO of U.S. growth equity, mid- and small-cap, at American Century Investments. He manages the Renaissance U.S. Equity Growth Fund.
You’re taking on more risk when investing in mid caps, he explains. But, even on a risk-adjusted basis, they tend to outperform small caps more than 95% of the time, and large caps nearly 60% of the time, due to structural opportunities that are inherent to the mid-cap space.
Further, “mid caps give you better upside potential than large caps, and much better downside protection than small caps.”
Hollond says, “We’re often overweight in mid caps. We [can] have up to 50% of our portfolio invested in that area of the market, while still offering our investors exposure to large-cap names like Apple, Google, [and] Mastercard.”
The problem, he adds, is mid caps are often overlooked by investors. “When people invest, one of the places they start is getting large-cap exposure. And when they say, ‘I need to diversify,’ they think first of small caps because those are the opposite. So, they own a bunch of large, mega-cap names and allocate some capital to small caps, but they completely skip over mid caps” despite their potential for higher risk-adjusted returns.
Don’t forget about banks
Hollond is currently overweight U.S. banks since they’re benefiting from the current economic upswing.
“Strong GDP growth means banks have the opportunity to grow their loan books at increasing rates,” he says. “Also, credit trends in the economy have been improving for years.”
Hollond suggests investors focus on finding good banks that are expected to drive growth at an accelerated rate. Investments should be based, he adds, “on the individual characteristics of banks, rather than on something that applies to all banks.”
For instance, “We [favour] Morgan Stanley because it’s transitioning from being a traditional investment [bank] to being a wealth manager. This transition will lead to more consistent earnings and, likely, a higher valuation.”
Hollond’s also invested in Silicon Valley Bank due its limited exposure to the energy sector. Due to current market drivers, he notes, investors will take on more risk if they add exposure to “smaller and medium-sized banks [that] have a high level of their loans in places that are tied to energy. We think there’s a lot of risk there.”