MDY Vs. IWR: The Index Followed Makes A Difference (NYSEARCA:IWR)

(This article was co-produced with Hoya Capital Real Estate)

Introduction

Two of my recent articles started exploring funds that invest below the S&P 500 Large-Cap stocks, as history shows they better returns. The first article reviewed the Vanguard Extended Market Index ETF (NYSEARCA:VXF), which invests in both Mid-Cap and Small-Cap stocks. The second explores the idea of using a Mid-Cap ETF and a Small-Cap ETF instead, so the investor controlled the allocation between the sizes: VO + VB Vs. VXF: Picking The Better ETF Strategy. It is from that second article that prompted this Mid-Cap focused one as my modeling of the proposed strategy said forget Small-Cap, just own Mid-Cap.

That leads me to look for Mid-Cap ETFs investors might invest in. Research shows investors have over a several dozen to choose from. Some are based on a different Index; some use a more focused strategy like dividends or equal-weighting. I chose the SPDR S&P MidCap 400 ETF Trust (NYSEARCA:MDY) and the iShares Russell Mid-Cap ETF (NYSEARCA:IWR) as they invest based on well known and followed indices.

Why Mid-Cap?

With Big Tech ruling the US market over the last decade, why worry about Mid-Cap stocks is a good question. The answer is based on the market returning to its historical pattern of rewarding investors for taking more risk, which most pundits would say happens when investing in smaller stocks.

Since 1972, Mid-Cap stocks have provided the best CAGR, Sharpe and Sortino ratios. The higher StdDev than Large-Cap stocks confirms they are riskier by that measure. In theory, Small-Cap should have the best returns, and occasionally they did since 1972.

Exploring the SPDR S&P MidCap 400 ETF Trust

Seeking Alpha describes this ETF as

The fund invests in stocks of companies operating across diversified sectors. The fund invests in growth and value stocks of mid-cap companies. It seeks to track the performance of the S&P MidCap 400 Index, by using full replication technique. SPDR S&P MidCap 400 ETF Trust was formed on April 27, 1995.

Source: seekingalpha.com MDY

MDY has amassed $20b in assets and currently yields just over 1%. Total fees are 23bps, which these days is high for an index-based ETF.

Understanding the Index

S&P describes the S&P MidCap 400 Index as

The S&P MidCap 400® provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500®, is designed to measure the performance of 400 mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment.

Source: spglobal.com MID Index

S&P lists over 20 ETFs that use this Index to measure their performance against. Several use only parts of the Index or weight differently, but since investors then expect such strategies to “beat” the basic Index, using it as a measuring stick makes logical sense.

Important characteristics of the S&P MidCap 400 Index include:

The next able shows how the market size has changed over time as the overall US equity market has moved:

Sector Breakdown

MDY assigns stocks to a sector based on the Global Industry Classification Standard (GICS), which was developed in a partnership between Standard & Poor’s and Morgan Stanley Capital International.

Investing in MDY versus the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) Large-Cap stocks does alter the sector allocations, with Technology going down and Industrials taking over as the largest sector allocation; Tech stocks are #3.

MDY Holdings review

Unlike its big sister, the Mid-Cap Index, thus MDY, is not top heavy. Whereas SPY has 29% in their Top 10, MDY is just over 6%, making is less dependent on a small subset of holdings to effect performance, good or bad.

MDY Distribution review

While few investors would buy MDY for the yield (1%), at least it has been growing over the past 3 and 5 years by more the 4.5%. Seeking Alpha’s grading system rates MDY as “A-” overall.

Exploring the iShares Russell Mid-Cap ETF

Seeking Alpha describes this ETF as

The fund is managed by BlackRock Fund Advisors. It invests in public equity markets of the United States. The fund invests in stocks of companies operating across diversified sectors. The fund invests in growth and value stocks of mid-cap companies. The fund seeks to track the performance of the Russell Midcap Index, by using representative sampling technique. iShares Trust – iShares Russell Mid-Cap ETF was formed on July 17, 2001.

Source: seekingalpha.com IWR

IWR is the bigger of the two ETFs at $29.3b in assets. The yield is slightly higher (1.1%) and fees slightly lower at 19bps.

Understanding the Index

Russell/FTSE describes the Russell Midcap Index as

The Russell Midcap® Index measures the performance of the mid-cap segment of the US equity universe. The Russell Midcap Index is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap® Index represents approximately 26% of the total market capitalization of the Russell 1000® companies.

Source: research.ftserussell.com Index

Important characteristics include:

• Index currently contains about 830 stocks
• Rebalancing only occurs annually in June with the other Russell indices
• Market caps: Average: $24.2b Median: $10.7b Largest: $58.5b

Sector breakdown

Dow Jones and FTSE have developed their own sector coding system, the Industry Classification Benchmark, or ICB. Since the website chart didn’t show percents and IWR allocations matched well, I chose not to include the Index sector pie chart. This next chart shows ICB’s structure.

Source

IWR Holdings review

Unlike MDY, Technology stocks replace Industrial (#2 here) as the top sector, though still less than what SPY holds. We examine the differences in more detail later.

IWR holds more than twice the number of stocks that MDY does, 835 currently. As one would suspect, IWR’s Top 10 represent a lower percent of the total assets, only 4.4%. None of the Top 10 match between the ETFs.

IWR Distribution review

Like MDY IWR earns a “A-” from Seeking Alpha for its dividend performance.

Comparing the ETFs

I will start by comparing how the current sector weights vary and biggest stock weighting differences.

Based on what we saw earlier, MDY having a larger Industrial exposure, with IWR’s biggest comparative “overweight” in Technology is to be expected. With our sector weights varying by 2+%, that could help explain possible performance differences, though keeping in mind these differences are today’s, not historical. Going forward, how one feels about those four sectors is important in doing deeper due diligence.

When comparing market weights, there is only a 16% overlap.

Both ETFs own 250 stocks in common, which equals 63% of the stocks held by MDY, but only 31% held by IWR. The next chart shows the 10 biggest stock weighting differences between the ETFs.

Six of the MDY overweights appear in that ETF’s Top 10 list. For IWR, the eight most overweight all appear it that ETF’s Top 10 list. Besides sectors, that presents more data to use in deciding which, if either, ETF to own for gaining Mid-Cap exposure. Next we look at some basic equity ratios.

While most of the ratios do not differ by much, MDY’s show a more Value bent to its holdings.

Except for Cash Flow, the other Growth percents all favor IWR. This would be expected if IWR was more growth-oriented in its allocation.

Since the ETFs appear to be Value Versus Growth, PortfolioVisualizer has history at that level. For Mid-Cap stocks, Value has definitely been better.

If you agree with my premise that MDY is more Value oriented, the above chart points in that direction, except the ETFs themselves show otherwise.

Until recently, IWR was the better performer, contrary to the upper chart showing Value stocks doing better. This could mean several things: my assumption of which is more Value/Growth is wrong or today’s allocation doesn’t reflect history well. This also reminds us that subsets of data do not always reflect the full dataset.

Portfolio Strategy

History shows Mid-Cap stocks, over the long run, have bettered both Large-Cap and Small-Cap stocks. Of course, for shorter periods that was not always the case. If we are entering a period of extended high inflation, could that favor a different asset size. The next chart shows how the classes did during the last such period, the mid-70s to early 80s.

While Mid-Cap did much better than Large-Cap, the Small-Cap stocks did even better. While not shown, Micro-Cap stocks were the best performers: 2.5X better than the Large-Caps. That said, do notice that the Small-Caps were down the most the first two years and were not on top until 1977.

Final thoughts

During the last six months, when inflation was taking on greater importance, the ETFs didn’t vary much in performance, but with IWR showing more weakness recently.

A reminder that the purpose of this article is to encourage investors to look “under the hood” before buying any fund. There are dozens of ETFs in this space, plus Mutual Funds and CEFs to pick from with many strategy differences. Investors should explore behind MDY and IWR before investing.

I found this article that explains the different approaches used by GICS and ICB to classify companies into what they deem to be the best sector.