Why we favour investing in mid-cap companies over large-caps

Understanding market capitalisation

Market capitalisation (market cap) is a measure of a company’s market value, helping investors assess things like size, risk, and growth potential. Categorising companies based on market cap, helps investors build balanced and focused portfolios based on certain investment characteristics.

Small-cap companies

Valued between $300 million and $2 billion, these companies are known for their high growth potential but can be more volatile.

Mid-cap companies

Valued between $2 billion and $10 billion, mid-caps offer a balance of growth and stability. These businesses are often expanding and gaining market share.

Large-cap companies

With valuations exceeding $10 billion, large-cap companies are established industry leaders with more stable and lower risk profiles.

Sustainability and investing in mid-cap companies

When building our equity exposure, we prioritise companies whose products and services address one or more of the United Nations Sustainable Development Goals (UN SDGs). This commitment to sustainability often leads us to favour small and mid-sized companies. These companies are typically more progressive, developing innovative solutions to specific social and environmental challenges. Their smaller size and growth-oriented nature allow them to adapt quickly to changing market demands and integrate sustainable practices at their core.

Long-term performance*: mid-cap companies vs. large-cap

Since 2000, the S&P 400, an index of US mid-cap companies, has delivered an 8.4% annualised return, compared to the S&P 500’s 5.6%,^[1] which tracks the largest US companies. However, like with all investments, there are times of relative underperformance when investing in mid-cap companies.

Over the past three years, the S&P 500 has delivered a 9.0% annualized return, while the mid-cap index returned 6.0%.^[2] Notably, excluding the “Magnificent 7” (Apple, Microsoft, Amazon, Google/Alphabet, Meta, Tesla, Nvidia), the remaining S&P 493 underperformed compared to mid-caps, returning only 5.3%.^[3]

*Past performance is not a reliable indicator of future performance.

Interest rates and their impact

The recent underperformance of small and mid-cap companies is largely due to interest rates. Smaller companies can be more vulnerable when interest rates are high, as they often rely on bank debt with variable floating rates, unlike larger companies that have easier access to fixed-coupon bonds. This situation reverses when rates begin to fall. In late 2023, a significant repricing of rate cut expectations led to a rally in mid-caps, a pattern also seen in July 2024.

Challenges with investing in mega-caps

Mega-cap companies, with market valuations over $200 billion, are rarely found in impact-focused portfolios. Despite their growth, especially driven by US-based tech companies, these companies often do not align with our focus on the SDGs. Issues like data security, privacy risks, and less integrated shareholder engagement, with technology companies specifically, make them less suitable for our investment strategies.

Merger and acquisition potential in mid-cap companies

Mid and small-caps are often attractive merger and acquisition targets for larger companies due to their higher growth potential. Acquiring these companies allows larger firms to enter new markets and gain innovative products or services. This can provide investors with potential returns as well as investment exposure to other sectors and regions. This year, one of our fund strategies benefitted from this trend, with three of its holdings being acquired in the first half of the year alone.

Drivers of economic growth

Mid-cap companies are often key innovators, focusing on new or emerging technologies. In emerging markets, mid-caps generate up to half of the national GDP, serving as cornerstones for economic development and employment.^[4]

Globally, over 50,000 mid-cap companies represent more than 40% of the global workforce and contribute to approximately one-third of most economies’ GDP.^[5] Their agility and innovation capacity make investing in mid-cap companies a driver of economic resilience and expansion, as mid-caps often lead in adopting and scaling new technologies and business models.

A compelling case for investing in mid-cap companies

Investing in businesses aligned with the SDGs naturally leads to a higher concentration in small and mid-cap companies. While smaller companies can be more vulnerable when interest rates are high, the expected decline in rates in the coming quarters could be good news for investing in mid-cap companies. Within our equity allocation, we view small and mid-caps as companies poised for growth and making a positive impact on the world.

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[1] Bloomberg (August, 2024)

[2] Bloomberg (August, 2024)

[3] Bloomberg (August, 2024)

[4] McKinsey & Company. (May, 2024). Unleashing the power of midcap companies.

[5] McKinsey & Company. (May, 2024). Unleashing the power of midcap companies.