Mid-Cap ETFs: Great Performance, Little Interest?

Sometimes, an excellent investment opportunity seems to hide in plain sight. Exchange-traded funds (ETFs) that track U.S. mid-cap companies may be one of those hidden opportunities.

The largest of these funds, the SPDR S&P MidCap 400 ETF Trust (MDY), has outperformed its competitors in the large-cap by a significant margin and has, for some periods, outperformed small cap as well. Nonetheless, it maintains a smaller collection of assets than either of these rivals. Indeed, Bloomberg Intelligence ETF analyst Eric Balchunas says that MDY would be the best bet among any ETF in history based on performance. So why aren't more investors clamoring to boost its inflows?

'Forgotten Middle Child'

Balchunas describes mid-cap ETFs as "the Jan Brady of the stock market, the forgotten middle child," adding that he "continue[s] to be amazed by mid-caps" even as he himself also forgets about them.

The Bloomberg report suggests that perhaps part of the reason why investors have neglected MDY and other mid-cap ETFs is that they lack the allure of themed funds, which are increasingly popular among younger investors. MDY does not focus on environmental, social and governace (ESG) issues, for instance. However, there are other mid-cap funds that aim to market themselves in this way; for example, Nuveen LLC launched two mid-cap ETFs based on these ESG criteria in late 2016, seeking to provide clients with a unique strategy that also offers a social impact focus.

Socially Responsible Investing Slower?

ESG has been gaining in importance in recent years, particularly in the ETF space. Nonetheless, investors' views of what constitutes a socially responsible investment tend to vary dramatically. Ultimately, Credit Suisse Group AG (CS) head of ETF market making Josh Lukeman believes that placing too high a premium on ESG "can squeeze the juice out of the best-performing sectors."

Besides, an ESG strategy is not a guarantor of success for mid-cap ETFs, according to Balchunas; for evidence of this, it's worth noting that neither of Nuveen's ESG mid-cap funds has been able to garner even $50 million in total assets. The first, the NuShares ESG Mid-Cap Value ETF (NUMV), has brought in returns of less than 1% year to date (as compared with a mid-cap company benchmark that has gained 5.7% over the same period).

At this stage, even when much more significant profits have been confirmed in non-ESG mid-cap ETFs, Nuveen is sticking fast to its strategy. Perhaps part of the reason for this is that the parent company of Nuveen, TIAA, is broadly committed to socially responsible investing (SRI) practices. Even still, some investors don't mind the slower path to profit through SRI mid-cap ETFs like Nuveen's.

CEO and founder of Hunter Financial Advisors Dan Juechter, for instance, holds money for clients in both of Nuveen's ESG mid-cap ETFs. He suggests that "over long periods of time, I think we're going to see that not only is it advantageous for the corporate culture to embrace this, but it's going to show in performance. At the end of the day, you have to have a certain degree of faith."

While faith in the performance of socially conscious mid-cap ETFs may be a virtue for some investors, others who are not as focused on the substrategy behind their investments could see much quicker and more dramatic profits with a basket of similarly sized companies, so long as they forgo the commitment to ESG. Whether it's a focus on ESG or perhaps outsized interest in other categories of ETFs, though, it appears that the broader ETF investor base has yet to fully appreciate the potential of other mid-cap ETFs like MDY.