Excellent interview from John Bogle, Founder of The Vanguard Group !!

Why I'm overweight Mid-caps ?

Mid cap companies are companies that have market cap between $2 to $12 billion. These companies are often been left out of basic asset allocation models. Mid-caps have already progressed through small cap status, and are likely to have proven business plans and more experienced management. Mid-cap companies are typically small companies that have succeeded. In most cases they are financially stable then their small cap counterparts. In some cases they are as stable as their large cap counterparts. 

Mega caps in S&P 500 or total market index have a disproportionate impact on the returns of midcap reducing its impact on the index. They protect better than small caps in down turn recessions and have/will bounce back faster than large caps. Mid-caps generally better withstand the depths of a downturn than small caps to emerge in a stronger financial condition when the economic environment improves. 

Mid-cap companies typically have higher cash flows and earnings acceleration compared to large cap companies. Mid-cap companies are often in the growth phase of the business lifecycle, where they may be experiencing their highest cash flows and earnings growth. If required, mid-cap companies typically can raise capital much better than small caps. 

Mid-cap companies receive less analyst coverage than large cap companies. The less coverage a particular segment receives, the more likely there are market inefficiencies to exploit. The fact that there is less overall research for mid-caps than large caps suggests that there are greater opportunities for active managers to capitalize on inefficiencies in the mid-cap market.

Another benefit of mid-caps is, they are prime targets for merger/acquisitions by large caps. Larger companies often target smaller rivals to increase their market opportunity and enhance their competitive positioning.

Mid-caps have consistently outpaced large and small caps over the past 30 years. See below

Here is the chart of midcap index vs s&p 500 vs Total market for the past 5 years (post mortgage crisis)

 

Here is the chart of midcap index vs s&p 500 vs Total market for the past 10 years

Here are the returns for the past 30 years-

Let’s say you invested $10,000 in 1978 in midcap, large cap and small cap’s evenly. From the below chart, mid-caps ended 2012 with $679,471 vs large caps at $399,115 vs small cap $390,237. Clearly mid-caps far outperformed large caps and small caps. 

 

For above reasons – I believe Mid-caps will outperform large and small caps in the long run and I’m overweight mid-caps.