Goldilocks learns an investment lesson

How Goldilocks invested the royalties from selling her three bears encounter is the part of the fairy tale not often told. When Goldilocks buys shares in companies, she insists that the company not be too big and not be too small – the so-called ‘mid-caps’. The ‘mighty mid-caps’ are often referred to as the sweet spot in the investment universe because they combine the attractive attributes of large and small companies.

Some mid-caps can be former small-caps that have grown up. They balance spirit and safety. They have experienced management teams, established brands and client bases, infrastructure already built, and access to capital markets – advantages that small-cap companies may lack.

At the same time, they benefit from flatter management structures, entrepreneurial drive and quick decision-making so can adapt more quickly than their large-cap counterparts.

Mid-caps are not business giants with a huge market share that make it impossible to grow more than a few per cent. Mid-caps still have room to capture market share, offer new products, enter new markets, gain economies of scale or obtain intellectual property quickly. They also have a much greater potential of being taken over than large-caps have. In addition, analysts cover large-caps in such depth there are no hidden gems to find.

The S&P/ASX Index Series defines mid-caps to be the stocks ranking from 51 to 100 by market capitalisation. The following graph shows the mid-cap index outperforming other key indices over the long term.

Chart 1: How the S&P/ASX indices perform

_{Source: Morningstar Direct, 31 March 2000 (commencement of S&P/ASX index series) to 30 June 2021. Results are calculated to the last business day of the month and assume immediate reinvestment of all dividends and exclude costs associated with investing in MVE. You cannot invest directly in an index. Past performance is not a reliable indicator of future performance of the MVE Index or MVE.}

Below we present this data in a different way. The rolling returns show the performance results over each previous period. In other words, in chart 2 each dot point represents the return for the previous 12 months, in chart 3 each dot represents the returns of the previous 5 years.

Chart 2: 12 month rolling returns of the S&P/ASX indices

_{Source: Morningstar Direct, 31 March 2000 (commencement of S&P/ASX index series) to 30 June 2021. Results are calculated to the last business day of the month and assume immediate reinvestment of all dividends and exclude costs associated with investing in MVE. You cannot invest directly in an index. Past performance is not a reliable indicator of future performance of the MVE Index or MVE.}

Chart 3: Five-year rolling returns of the S&P/ASX indices

_{Source: Morningstar Direct, 31 March 2000 (commencement of S&P/ASX index series) to 30 June 2021. Results are calculated to the last business day of the month and assume immediate reinvestment of all dividends and exclude costs associated with investing in MVE. You cannot invest directly in an index. Past performance is not a reliable indicator of future performance of the MVE Index or MVE.}

What is evident in both is that there are times when the mid-caps underperform the larger-caps. If we focus on chart 2, the last few months is a good case in point. In March this year, mid-caps were the best performing index for the previous 12 months. It was the second highest 12-month performance ever recorded by an S&P/ASX index. Fast forward three months and the mid-cap index is back in-line with the large-caps indices. Price fluctuations tend to be bigger in mid- and small-caps as the below table shows. Referring to the table below, the S&P MidCap 50 has the highest best month and best quarter, but the second lowest worst month and worst quarter.

Table 1: Returns and risk of S&P/ASX 200 indices since 2000

_{Source: Morningstar Direct, 31 March 2000 (commencement of S&P/ASX index series) to 30 June 2021. Results are calculated to the last business day of the month and assume immediate reinvestment of all dividends and exclude costs associated with investing in MVE. You cannot invest directly in an index. Past performance is not a reliable indicator of future performance of the MVE Index or MVE.}

Goldilocks, like any investor does not like to lose money, but recognises that timing the market, is impossible.  

As with any investment strategy, diversification reduces the risk without, according to Modern Portfolio Theory, giving up too much of the return. Goldilocks is considering two ways to invest in Australian mid-caps. The first, the VanEck Vectors S&P/ASX MidCap ETF (MVE) gives Goldilocks one trade access to a portfolio that tracks the S&P/ASX Midcap 50 Index.

The other approach Goldilocks is considering is the VanEck Vectors Australian Equal Weight ETF (MVW). MVW invests in the most liquid ASX-listed companies across both large caps and mid-caps, with a greater exposure to mid-caps than you would get from a market capitalisation index approach like a fund that tracks the S&P/ASX 200. This is because MVW equally weights each constituent as opposed to a market capitalisation approach that weights each stock proportional to its size so the biggest companies make up a bigger proportion of the fund. MVW has more invested in mid-caps and less invested in Australia’s mega-caps.

Goldilocks can add mega-cap and high conviction ideas to both of these portfolios.

Goldilocks is learning that ETFs are useful trading tools for portfolio construction – a lesson almost as important as not stealing, not vandalising furniture and not falling asleep in your victim’s bed.