In a traditional portfolio, mid-cap and small-cap equities receive much smaller weights than large-caps. For example, the most recent moderate asset allocation model portfolio recommended by the S&P Capital IQ Investment Policy Committee (see in the November 24, 2014 edition of the S&P The Outlook), consists of the following allocations:
- 50% to U.S. equities
- 15% to foreign equities
- 25% to bonds
- 10% to cash
To achieve the model allocation, the committee recommends specific ETFs for the 50% U.S. equity part of the portfolio:
- 40% in large-cap blend ETF, the SPDR® S&P 500® ETF (SPY)
- 6% in mid-cap blend ETF, the SPDR® S&P MIDCAP 400® ETF (MDY)
- 4% in small-cap blend ETF, the iShares Core S&P Small-Cap ETF (IJR)
Therefore, the mid-cap and small-cap stocks collectively account for only 20% of domestic equities in the portfolio. Is such a low allocation justified by historical performance of these asset classes? Let’s take a look using the Portfolio Service of the Alpholio™ App for Android.
The longest analysis time frame is determined by the existence of IJR, whose first full monthly return was in June 2000 (SPY’s first monthly return was in February 1993, and MDY’s in June 1995). Here are the statistics of a portfolio solely composed of SPY in a period from that month through 2014:
Similarly, for MDY:
And for IJR:
The mid-cap (MDY) and small-cap (IJR) ETFs had annualized returns more than twice that of the large-cap ETF (SPY). The Sharpe ratios of MDY and IJR were also approximately twice that of SPY. While IJR outperformed MDY in terms of the annualized return, alpha and Sharpe ratio (just slightly), it also had the highest standard deviation (volatility), maximum drawdown and beta of all three ETFs. Therefore, the mid-cap ETF appears to be a decent compromise between risk and reward.
For the 10-year period through 2014, the statistics are as follows:
|ETF||Annualized Return||Standard Deviation||Alpha*||Beta*||Sharpe Ratio||Max. Drawdown|
* In this analysis period, alpha and beta are measured against a broader market index, represented by the Vanguard Total Stock Market ETF (VTI).
In the evaluation period, MDY clearly outperformed its peers by generating the highest annualized return, alpha and Sharpe ratio, while having the lowest maximum drawdown.
Another service offered by the Alpholio™ App for Android is the Rolling Returns analysis. In the 10-year period through 2014, SPY returned more than VTI in about 9.4% of all rolling 36-month periods (a rolling period of 36 months aims to approximate the average holding time of the ETF in an investment portfolio):
However, in the same period, MDY outperformed VTI in about 75.3% and IJR in 70.6% of all rolling 36-month periods. Based on this simple measure (it does not take risk into account), MDY again demonstrated a superior performance.
While past performance is not a guarantee of future results, this analysis indicates that mid-cap equities may deserve a higher allocation even in a moderate-risk portfolio. A follow-on post will examine the characteristics of growth vs. value equities, also using services of the Alpholio™ App for Android. The app is available at: