Why It’s Time to Think Small- and Mid-Cap Investing

Why small- and mid-cap stocks?

Small and mid-cap stocks have historically offered a return premium over larger cap stocks. That's what's so compelling about the smaller cap spectrum at any given time.

I think what's even more compelling right now is that return premium—that outperformance that small and mid-cap stocks have delivered over very long periods of time relative to large cap stocks—simply hasn't played out for the last decade.

Smaller cap stocks have lagged. Large cap stocks have driven returns in the market. We are at a point where a lot of dynamics in the market are starting to turn, and we're seeing value over growth and a lot of other areas of the market behave differently than they have over the last decade.

I think with valuations of small- and mid-cap stocks where they're at right now relative to large-cap stocks—multi-decade lows—and the fact that that return premium that has historically been offered by smaller cap stocks, the fact that it hasn't delivered for the better part of the last decade points to potential upside for the small- and mid-cap area of the U.S. equity market.

Is the SMID-cap space hard for investors to navigate?

Investors looking to the small- and mid-cap—or SMID-cap—area of the market face various risks that differ than your average large cap household name stock. These companies tend to be smaller, of course, and come with a little bit more volatility, so the expected or potential risk is generally, or hopefully, outweighed by the potential return.

But it's very difficult for investors to identify those great companies within the small-cap spectrum.

If you think of this, large cap companies on a company count perspective represent only about 15% of the U.S. equity market.

But when you look at market cap or market value, large cap companies represent about 75% of the market.

Most investors when they look to indexes or other investment vehicles are getting mostly large-cap U.S. equity exposure in a U.S. equity fund. And so it's very difficult amongst the many small-cap companies that represent much smaller portions of investor portfolios, to get the information they need to make sound investment decisions around smaller cap companies. So, less efficient, less covered area of the market create hurdles for small- and mid-cap investors.

How does Morningstar approach investing in SMID-cap stocks?

Morningstar applies the same investment philosophy it has long applied to larger cap companies in the U.S. markets to small and mid-cap companies. This revolves around identifying companies that have created a sustainable competitive advantage—one that is built to last—and also allocating to those companies when they appear attractively priced relative to their fair value.

Morningstar helps solve the information gap in small and mid-cap companies by providing equity research on over 1,500 companies globally, many of which are smaller cap in nature.

Morningstar allows investors to tap the SMID cap segment of the market with confidence by knowing that they're allocating to companies Morningstar believes have developed a competitive advantage and are also trading at attractive valuations.

VanEck Morningstar SMID Moat ETF (ticker: SMOT) seeks to track a Morningstar index offering exposure to small and mid-cap companies with competitive advantages trading at attractive valuations.