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Mighty midcaps may be an overlooked portion of the US equity market

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      By Charles GaffneyEquity Portfolio Manager, Eaton Vance Management

      Boston - Since hitting its low point for the year on March 23, the Russell Midcap Index has rallied 44.0% through May 31, placing it 6.0% ahead of the Russell 1000 Index and 4.5% ahead of the Russell 2000 Index. Despite delivering historically compelling absolute and risk-adjusted returns versus their large-cap and small-cap counterparts, we find that midcaps are an often-neglected segment of the US equity market.

      Generally speaking, financial media tends to focus on large caps, while academic research tends to favor small caps. In our experience, investors often turn to large caps for their more mature, stable businesses and small caps for their dexterity and growth. This may lead, in part, to many investors being less attuned to the potential merits of the midcap space, where market capitalizations typically range from $3 billion to $20 billion.

      Midcap spells opportunity

      We believe midcaps deserve close attention as investors think about portfolio allocation in this difficult environment, especially by those with a long-term outlook. Midcaps are a sort of "melting pot," on the whole offering greater growth potential than large caps and more stability than small caps. Notably, since the Russell Midcap Index's inception in November 1991 through March 31, 2020, midcaps have significantly outpaced their large and small-cap peers, as shown in the chart below.

      0601Midcapschart

      Over 10-year rolling periods, the Russell Midcap Index outperformed the Russell 1000 Index by an average of 2.36%, and the Russell 2000 Index by an average of 1.72%. In addition, midcap Sharpe ratios, a measure of risk-adjusted performance, were higher during this period.1

      An eye on long-term, secular trends

      Over the short term, we are taking a deep look at the liquidity and balance-sheet strength of our holdings, while also seeking to take advantage of market dislocations to invest in sustainable businesses that we believe demonstrate the propensity to be long-term winners.

      Looking ahead, we have given a lot of thought to what long-term secular trends might emerge from this unprecedented period. A prime example we see is the acceleration of digital payments, which have transitioned from a nice-to-have service to a virtual necessity. More consumer spending has shifted to online, with physical cash being perceived as "dirty," and more businesses are seeking ways to pay their suppliers digitally. Governments are also discovering that digital-payment technology needs to be a critical part of national infrastructure, especially after the delays experienced in distributing loans and stimulus payouts. We believe it's essential to understand these trends — and the underlying businesses that stand to benefit most — as we position our portfolios across the midcap landscape to emerge successfully from this crisis.

      Bottom line: Often overlooked, we believe midcap stocks may offer an attractive option for investors to consider in the current, difficult market. Midcaps have tended to be more stable than small caps, with more growth potential than large caps — and have historically offered higher, long-term risk-adjusted returns than either one.