Three Reasons to Consider SMID-Caps During a Declining Rate Environment
24 October 2024
Read Time 4 MIN
The Fed finally began easing monetary policy, announcing a 50-basis point cut during its September meeting. While the magnitude of the first cut has been a source of debate (50 bps vs 25 bps), the main topic on the minds of advisors is how to adjust strategic asset allocations in a broader environment of declining interest rates.
Looking at previous periods of monetary easing, rate cuts have had a positive impact on small and mid-cap companies. These smaller firms typically carry more debt than larger corporations, making them more sensitive to rising interest rates. As long as the economy remains stable and avoids a recession, historical trends show that rate cuts generally provide stronger support for smaller-cap stocks compared to their large-cap counterparts.
Below we discuss three reasons why advisors may consider small- and mid- cap stocks now.
Valuations could Create an Attractive Entry Point
- Small and mid-cap stocks are trading at a significant discount compared to their large-cap counterparts, presenting an attractive entry point for investors.
- Historically, valuation gaps between large and smaller companies tend to close over time, potentially paving the way for outsized gains as the market corrects this disparity and valuations revert to the mean.
SMID Cap Valuations Are At 20 Year Lows Relative To Large Caps
Source: VanEck, Morningstar. Data as of 30/09/24. SMID cap and large cap stocks are represented by the Russell 2500 Index and S&P 500 Index, respectively.
Strong Historical Relative Performance during Past Rate Cut Periods1
- Smaller companies historically benefit more during rate-cut cycles, as cheaper borrowing costs fuel growth and expansion, often leading to stronger earnings growth.
- As monetary policy loosens, investors typically rotate from safe, large-cap investments to higher-growth opportunities such as small-cap stocks.
- Data from the five previous rate-cut periods since 1995 shows that small and mid-cap stocks have consistently outperformed large-cap stocks, especially over a longer time horizon following the first rate cut.
Average Performance during Previous 5 Rate Cuts (since 1995)
Source: VanEck, Morningstar. Small caps, mid caps and large caps are represented by the S&P Small Cap 600 Index, S&P Mid Cap 400 Index, and S&P 500 Index, respectively. Periods of rate cuts start in 1995 and cover the following 5 periods: 06/07/1995, 29/09/1998, 03/01/2001, 18/09/2007, and 01/08/2019.
Winning during Election Years (and Beyond)
- Changes in government policy and fiscal initiatives can often favor smaller businesses, with many mid- and small-cap companies positioned to benefit from proposed regulatory shifts and / or infrastructure spending.
- Data from previous election years shows that small and mid-cap stocks have consistently outperformed large-cap stocks.
Average Performance during Previous Election Years (since 1996)
Source: VanEck, Morningstar. Small caps, mid caps and large caps are represented by the S&P Small Cap 600 Index, S&P Mid Cap 400 Index, and S&P 500 Index, respectively. Time period of analysis starts in 1996 and includes the month of November in the after-election returns.
Tap into the Power of Moat Investing
While the broader backdrop is favorable for the SMID-cap asset class, it’s important to remember that small and mid-cap stocks have a wide range when it comes to quality. In fact, 41% of small cap companies and 17.5% of mid cap companies are unprofitable1. In addition, the lack of analyst coverage and research for small- and mid-cap stocks can lead to greater dispersion between a SMID-cap company’s stock price and fair value.
The VanEck Morningstar US SMID Moat UCITS ETF (SMOT) might help investors gain exposure to the tailwinds behind the SMID asset class and avoid the lower-quality unprofitable companies. Leveraging Morningstar’s equity research team, SMOT provides focused exposure to SMID-cap stocks, targeting companies with long-term competitive advantages and attractive valuations.
SMOT seeks to track the Morningstar® US Small-Mid Cap Moat Focus IndexSM, which leverages Morningstar’s forward-looking, rigorous research process, driven by over 100 analysts globally. The Index applies much of the same core index methodology principles as Morningstar’s flagship Wide Moat Focus Index, but to a universe of small- and mid-cap companies. The Index targets SMID-cap companies with long-term competitive advantages, known as moats, and attractive valuations.
Main risk factors
Foreign Currency Risk: Because all or a portion of the Fund are being invested in securities denominated in foreign currencies, the Fund’s exposure to foreign currencies and changes in the value of foreign currencies versus the base currency may result in reduced returns for the Fund, and the value of certain foreign currencies may be subject to a high degree of fluctuation.
Equity Market Risk: The prices of the securities in the Fund are subject to the risks associated with investing in the securities market, including general economic conditions and sudden and unpredictable drops in value. An investment in the Fund may lose money.
Limited Diversification Risk: The Fund may invest a relatively high percentage of its assets in a smaller number of issuers or may invest a larger proportion of its assets in a single issuer. As a result, the gains and losses on a single investment may have a greater impact on the Fund's Net Asset Value and may make the Fund more volatile than more diversified funds.
Risk of investing in smaller companies: The securities of smaller companies may be more volatile and less liquid than the securities of large companies. Smaller companies, when compared with larger companies, may have a shorter history of operations, fewer financial resources, less competitive strength, may have a less diversified product line, may be more susceptible to market pressure and may have a smaller market for their securities.
For more information on risks, please see the “Risk Factors” section of the relevant Fund’s prospectus, available on www.vaneck.com. Always read the KID and the prospectus before investing in a fund.
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1 JPMorgan Guide to the Markets
IMPORTANT INFORMATION
This is a marketing communication for professional investors only. Please refer to the UCITS prospectus and to the Key Investor Information Document (KIID) before making any final investment decisions.
This information originates from VanEck Securities UK Limited (FRN: 1002854), an Appointed Representative of Sturgeon Ventures LLP (FRN: 452811) which is authorised and regulated by the Financial Conduct Authority in the UK. The information is intended only to provide general and preliminary information to FCA regulated firms such as Independent Financial Advisors (IFAs) and Wealth Managers. Retail clients should not rely on any of the information provided and should seek assistance from an IFA for all investment guidance and advice. VanEck Securities UK Limited and its associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this information. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results. Information provided by third party sources is believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Brokerage or transaction fees may apply.
VanEck Asset Management B.V., the management company of VanEck Morningstar US Wide Moat UCITS ETF (the "ETF"), a sub-fund of VanEck UCITS ETFs plc, is a UCITS management company incorporated under Dutch law registered with the Dutch Authority for the Financial Markets (AFM). The ETF is registered with the Central Bank of Ireland, passively managed and tracks an equity index. Investing in the ETF should be interpreted as acquiring shares of the ETF and not the underlying assets.
VanEck Asset Management B.V., the management company of VanEck Morningstar US SMID Moat UCITS ETF (the "ETF"), a sub-fund of VanEck UCITS ETFs plc, is a UCITS management company incorporated under Dutch law registered with the Dutch Authority for the Financial Markets (AFM). The ETF is registered with the Central Bank of Ireland, passively managed and tracks an equity index. Investing in the ETF should be interpreted as acquiring shares of the ETF and not the underlying assets.
The Morningstar® Wide Moat Focus IndexSM are service marks of Morningstar, Inc. and have been licensed for use for certain purposes by VanEck. VanEck Morningstar US Wide Moat UCITS ETF (the “ETF”) is not sponsored, endorsed, sold or promoted by Morningstar, and Morningstar makes no representation regarding the advisability of investing in the ETF.
Morningstar® US Small-Mid Cap Moat Focus IndexSM are service marks of Morningstar, Inc. and have been licensed for use for certain purposes by VanEck. VanEck Morningstar US SMID Moat UCITS ETF (the “ETF”) is not sponsored, endorsed, sold or promoted by Morningstar, and Morningstar makes no representation regarding the advisability of investing in the ETF.
The S&P 500 Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 2020 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of S&P Global and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.
It is not possible to invest directly in an index.
Investors must read the sales prospectus and key investor information before investing in a fund. These can be obtained free of charge at www.vaneck.com, from the local information agent Computershare Investor Services PLC or from the Management Company.
All performance information is based on historical data and does not predict future returns. Investing is subject to risk, including the possible loss of principal.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.
© VanEck Securities UK Limited
Important Disclosure
This is a marketing communication for professional investors only. Please refer to the UCITS prospectus and to the Key Investor Information Document (KIID) before making any final investment decisions.
This is a marketing communication for professional investors only. Please refer to the UCITS prospectus and to the Key Investor Information Document (KIID) before making any final investment decisions. This information originates from VanEck Securities UK Limited (FRN: 1002854), an Appointed Representative of Sturgeon Ventures LLP (FRN: 452811) which is authorised and regulated by the Financial Conduct Authority in the UK. The information is intended only to provide general and preliminary information to FCA regulated firms such as Independent Financial Advisors (IFAs) and Wealth Managers. Retail clients should not rely on any of the information provided and should seek assistance from an IFA for all investment guidance and advice. VanEck Securities UK Limited and its associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this information. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results. Information provided by third party sources is believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Brokerage or transaction fees may apply.
VanEck Asset Management B.V., the management company of VanEck Morningstar US Sustainable Wide Moat UCITS ETF (the "ETF"), a sub-fund of VanEck UCITS ETFs plc, is a UCITS management company under Dutch law registered with the Dutch Authority for the Financial Markets (AFM). The ETF is registered with the Central Bank of Ireland, passively managed and tracks an equity index. Investing in the ETF should be interpreted as acquiring shares of the ETF and not the underlying assets. Investors must read the sales prospectus and key investor information before investing in a fund. These can be obtained free of charge at www.vaneck.com, from the local information agent Computershare Investor Services PLC or from the Management Company.
Morningstar® US Sustainability Moat Focus Index is a trade mark of Morningstar Inc. and has been licensed for use for certain purposes by VanEck. VanEck Morningstar US Sustainable Wide Moat UCITS ETF is not sponsored, endorsed, sold or promoted by Morningstar and Morningstar makes no representation regarding the advisability in VanEck Morningstar US Sustainable Wide Moat UCITS ETF.
Effective December 17, 2021 the Morningstar® Wide Moat Focus IndexTM has been replaced with the Morningstar® US Sustainability Moat Focus Index.
Effective June 20, 2016, Morningstar implemented several changes to the Morningstar Wide Moat Focus Index construction rules. Among other changes, the index increased its constituent count from 20 stocks to at least 40 stocks and modified its rebalance and reconstitution methodology. These changes may result in more diversified exposure, lower turnover and longer holding periods for index constituents than under the rules in effect prior to this date.
It is not possible to invest directly in an index.
All performance information is based on historical data and does not predict future returns. Investing is subject to risk, including the possible loss of principal.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.
© VanEck Securities UK Limited
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