why mid-cap? white paper - mar 2010

8/9/2019 Why Mid-Cap? White Paper - Mar 2010

1/8

A WHITE PAPER FROM RIDGEWORTH INVESTMENTSFirst Quarter 2010

Why Mid-Cap?

Executive SummaryThis paper details why investors should consider a specific allocation tomid-caps. They have offered investors:

Long record of outperformance mid-caps have outperformed other cap sizes overshort and long time periods ending December 31, 2009.

Consistent record of outperformance mid-caps have outperformed large caps andsmall caps for the majority of rolling periods within the last 30 years.

Better risk/reward relationship in periods ranging from 1- to 30-years, mid-caps havehad a higher sharpe ratio than other cap sizes (see graph below).

Strong risk-adjusted return over full market cycles mid-caps have historicallyoutperformed small caps heading into recessions and large caps coming out.

Strong position in the current market environment mid-caps have historically donewell in the periods following market bottoms.

Positive addition to an allocated portfolio adding an allocation of up to 40% in mid-caps has improved the risk/reward relationship of portfolios that only had large cap andsmall cap allocations.

-0.5

0.0

0.5

1.0

1.5

2.0

30 Year20 Year15 Year10 Year5 Year3 Year1 Year

Russell 1000 Index (Large Caps)Russell Midcap Index (Mid-Caps)Russell 2500 Index (Smid Caps)Russell 2000 Index (Small Caps)

Sharpe Ratio Comparison of Select Russell Indices Since 1979

PG 1

Shar

peRatio


2/8

IntroductionMid-cap stocks have often been left out of basic asset allocation models, to the detriment of long-term investors. Although they make up approximately 27% of the domestic equity universe,1 only15% of mutual fund assets invested in Morningstars equity style box are invested in funds that areclassified as mid-cap (as of 12/31/09).

Mid-caps have far outpaced large and small caps over the past 30 years, and have beaten them in amajority of rolling periods within it. They have generally protected the downside better than small capsgoing into recessions and bounced back faster than large caps coming out providing a risk-adjustedreturn that has been superior to both. A portfolio that included a specific allocation to mid-cap stockshad a better risk/reward relationship than a portfolio without over short and long time periods.

Those who invested in funds benchmarked to the Russell 1000 Index in an attempt to satisfy mid-capexposure have generally not realized the full benefits of mid-caps. The mega-caps within the Russell1000 (Russell 200 Index) have had a disproportionate impact on the returns of the Russell 1000 overthe past 30 years, dampening the positive impact of the mid-caps in the index. If an investor has notmade a specific allocation to mid-caps, now may be an opportune time to add them.

A Long Record of OutperformanceAn investment in mid-caps in 1979 would have significantly

outpaced large, smid and small caps over the next threedecades (see Exhibit 1). A $10,000 investment in mid-capswould have grown to nearly $470,000 $175,000+ greaterthan either large or small caps.

The historical performance of mid-caps becomes more

impressive when analyzing time periods that span 30 years.

For the period ending 12/31/09, the annualized returns of mid-

caps were higher than the other three market caps for the 1-,

3- , 5-, 10-, 15-, 20- and 30-year time periods. (see Exhibit 2)

$468,999

$401,974

$291,170

$275,687

$600,000

500,000

400,000

300,000

200,000

100,000

07 9 8 1 8 3 8 5 8 7 8 9 9 1 9 3 9 5 9 7 9 9 0 1 0 3 0 5 07 0 9

Russell 1000 Index (Large Caps)Russell Midcap Index (Mid-Caps)Russell 2500 Index (Smid Caps)Russell 2000 Index (Small Caps)

-10

0

10

20

30

40

50


TotalReturns

Russell 1000 IndexRussell Midcap IndexRussell 2500 IndexRussell 2000 Index

EXHIBIT 1: Growth of a $10,000 Investmentin Select Russell Indices Since 1979

Source: Russell Family of Indexes, Fact Set, 12/31/09

1 Using the Russell 3000 Index to represent the domestic equity universe and the Russell Midcap Index to represent mid-caps. As of 12/31/09

WHY MID-CAP?

A WHITE PAPER FROM RIDGEWORTH INVESTMENTS

PG 2


EXHIBIT 2: Annualized Return Comparison of SelectRussell Indices Since 1979


3/8

Mid-cap outperformance may be attributed to a numberof factors, including:

Mid-cap companies are typically small cap companiesthat have succeeded. Mid-caps have alreadyprogressed through small cap status, and are likelyto have proven business plans and more experiencedmanagement.

Mid-cap companies typically have greater financialliquidity and better capital-raising ability than small

caps. Mid-caps are generally better able to withstandthe depths of a downturn than small caps to emergein a stronger financial condition when the economicenvironment improves.

Mid-cap companies typically have higher cash flowsand earnings acceleration compared to large cap

companies. Mid-cap companies are often in the growthphase of the business lifecycle, where they may be

experiencing their highest cash flows and earningsgrowth.

Mid-cap companies receive less analyst coveragethan large cap companies. The less coverage aparticular segment receives, the more likely there aremarket inefficiencies to exploit. The fact that thereis less overall research for mid-caps than large caps(six of the largest 10 Russell Midcap companies have

fewer than 15 analysts covering them, comparedto one of the largest 10 Russell 200 companies1)suggests that there are greater opportunities foractive managers to capitalize on inefficiencies in themid-cap market.

A Consistent Record ofOutperformance

Mid-cap stock outperformance has been consistentover time. Over rolling time periods ranging from 1 to10 years, mid-caps have outperformed large and smallcaps well over half the time. In rolling 10-year periods,

mid-caps outperformed small caps every single time.(see Exhibit 3 and visit www.addmidcap.com to test theclaim). The importance of the 10-year period, where mid-caps have exhibited their highest rate of outperformance,is that it has often captured both recessionary andexpansionary periods.

The most recent 10-year period includes the currentrecession beginning December 2007, the previous

recession which lasted from April 2001 throughNovember 2001 and the expansionary period in between.

Mid-caps beat small caps 100% of the time in10-year rolling periods

Mid-caps have greater information opportunitythan large caps (less analyst coverage)

Visit www.addmidcap.com for comparisons to othercap sizes

WHY MID-CAP?


EXHIBIT 3: Percent of Time Mid-Caps Outperform Largeand Small Caps

0

20

40

60

80

100

Rolling120 Months

Rolling60 Months

Rolling36 Months

Rolling12 Months

66.5

%

57.3

%

73.3

%

55.5

%

87.9

%

62.9

%

100.0

%

63.6

%

% Russell Midcap Outperforms Russell 2000% Russell Midcap Outperforms Russell 1000

%o

fTimeMid-CapsOutperformed

Source: Russell Family of Indexes, Fact Set, 12/31/091 Source: FactSet, First Call, Russell Investments

PG 3


4/8

A Better Risk/Reward RelationshipThough mid-caps have exhibited volatility levels that are more consistent with their small cap peers since the start ofthe current recession, over longer time periods the standard deviation of mid-caps has been closer to large caps. Higherabsolute returns relative to both large cap and small cap stocks and standard deviation that is more aligned with largecaps have provided mid-cap investors with a superior risk/reward relationship. Using the Sharpe Ratio as a measure ofrisk/reward, mid-caps had a higher Sharpe Ratio than large, smid and small caps over each of the periods ranging fromone to 30 years. (see Exhibit 4)

Upside/Downside capture is an alternative method for

analyzing the relative risk of an investment. For the vast

majority of rolling 3-year periods over the last 30 years,

mid-caps have participated in the majority of the upside

relative to other cap sizes, while avoiding much of the

downside of smid and small caps. (see Exhibit 5)

PG 4

WHY MID-CAP?


Russell 1000 Index

Russell Midcap Index

Russell 2500 Index

Russell 2000 Index

200

180

160

140

120

100

80

60

40

20

0

0 20 40 60 80 100 120 140 160 180 20

Upside%

Downside %

EXHIBIT 5: Upside/Downside Capture ofSelect Russell Indices Since 1979

Source: Zephyr, 12/31/09

Mid-caps have had higher Sharpe Ratios than othercap sizes

Mid-caps participated in much of the upside, withoutall of the downside of smaller cap sizes

0.5

0.0

0.5

1.0

1.5

2.0


Russell 1000 IndexRussell Midcap IndexRussell 2500 IndexRussell 2000 Index

EXHIBIT 4: Sharpe Ratio Comparison of Select Russell Indices Since 1979


SharpeRatio


5/8

Performance Over Economic CyclesEconomic cycles are loosely defined as fluctuations ingrowth patterns caused by overall economic and financialtrends, competitive forces as well as the nature of supplyand demand. While these cycles may be predictable inpattern, they are rarely predictable in duration.

The current equity market is no exception as it is beginning

to exhibit some familiar patterns relative to past recessions notably the 1980, 1982, 1990 and the 2001 recessions.Looking back on these four recent recessions, bearmarkets, on average, have bottomed four months prior to

the official end of the recession. (see Exhibit 6) Anotherfamiliar pattern has been the performance of mid-capsrelative to large caps (represented by the S&P 500) aroundthe market bottom. The exhibit clearly illustrates that asthe market approaches the bottom, mid-caps have tended

to underperform large caps, but once the recession end isestablished, mid-caps have progressively outperformedlarge caps as the economy recovers. This illustration ofthe economic cycle suggests that mid-cap stocks tendto underperform large caps when investor fear and riskaversion are rising, but steadily outperform as investorsregain confidence in the market.

EXHIBIT 6: Mid-Cap/Large Cap Ratio Around Recession End Dates

The CBOE Volatility Index (VIX) is a measure of expectedvolatility. Often referred to as the investor fear gauge, theVIX is a forward-looking metric that uses S&P 500 Indexoptions to indicate the markets expectation of 30-dayvolatility. A measure of less than 20 reflects expectationsof relatively low volatility, while higher than 30 indicatesrelatively high volatility.

Exhibit 7 shows the relationship between the VIX and the

ratio between mid-cap and mega cap returns over the

past 20 years. The graph demonstrates that there has

been an inverse relationship between mid-caps (relative tomega caps) and volatility. When volatility spiked, the ratio

between mid-caps and mega caps declined, as mega caps

outperformed mid-caps. As volatility receded, the ratio

increased indicating that mid-caps outperformed mega caps

The volatility spikes occurring during the 1990s recessioncoincided with a period of mid-cap underperformance.During the last expansionary period, volatility measuresfell below 20 and mid-caps enjoyed a period of escalatingoutperformance. In late 2008, expectations of volatilityspiked to 80, corresponding with a brief period ofunderperformance for mid-caps, but when expected

volatility decreased mid-caps began outperforming again.

EXHIBIT 7: Ratio of Mid-Cap/Mega Cap Returns vs.the CBOE Volatility Index (VIX)

Source: FactSet, 12/31/09

PG 5

WHY MID-CAP?


Months After

BearMarketBottom

RecessionEndDate

96

97

98

99

100

101

102

103

104

105

106

107

108

109

-1-2-3-4-5-6-7-8-9-10-11-12 0 +1 +2 +3 +4 +5 +6 +7 +8 +9 +10 +11 +12 +13 +14 +15 +16 +17 +18 +19 +20 +21 +22 +23 +24

Months Before

Source: Ned Davis Research, 12/31/09

Bear market bottoms have occurred an average of 4 mont hs before recession end dates. Mid-caps = Russell Midcap Total Return Index . Large caps = S&P 500 Total Return Index MonthlyData Starting in 1978

Copyright 2010 Ned Davis Research, Inc. Further distribution prohibited without priorpermission. All Rights Reserved.

See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer towww.ndr.com/vendorinfo/.

Recession % Change % ChangeEnd Dates 6 Months Later 12 Months Later

7/31/1980 1. 63 7.54

11/30/1982 3. 84 1.99

3/31/1991 2. 81 7.49

11/30/200 1 11. 46 8.71

Mean 4. 94 6.43

The current recession is exhibiting familiar patterns

Mid-caps have accelerated faster than large capscoming out of recessions

In the last four recessions, the bear market bottomed anaverage of four months before the recessions end

R

atioofMid-Cap/LargeCapReturns

V

olatilityIndex

0

20

40

60

80

100

120

140 CBOE Market Volatility Index - Price IndexRussell Midcap - Index / Russell Top 200

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09


6/8

The opposite relationship has generally been truewhen comparing mid-caps to small caps. (see Exhibit8) When expected volatility was rising, mid-caps usuallyoutperformed small caps. Immediately after periods of highvolatility, small caps have tended to outperform mid-caps.

In 2008, the relationship broke down for a brief period afterLehman declared bankruptcy and volatility soared. Somebelieve that the environment drove many mid-cap investorsout of the market negatively impacting performance whilespeculators dampened the negative impact on small caps.

EXHIBIT 8: Ratio of Mid-Cap/Small Cap Returns vs.the CBOE Volatility Index (VIX)

Source: FactSet, 12/31/09

Mid-Caps and the Current MarketEnvironment

Though the exact timing of the recessions end is stillunknown, the markets behavior since March 2009 signalsthat the transition from recession to expansion is alreadywell underway. As this transition continues, a number ofcurrent and expected environmental factors bode well formid-cap stocks and active mid-cap managers.

Increasing investor risk appetites The continuing

movement away from liquid to longer-term assetsprovides mounting evidence of growing investor risk

appetites. According to Morningstar, long-term fundsnetted a combined $59.2 billion in November andDecember, while money market funds experienced netoutflows of nearly $47.8 billion over the same two months

Recent outperformance of consumer discretionaryversus consumer staples Beginning in the second

quarter, the consumer discretionary sector, whichis believed to be an indicator of the U.S. economyshealth, outperformed the consumer staples sector. Thattrend has continued. In the fourth quarter, consumerdiscretionary returned 7.85% within the Russell 3000,while consumer staples returned 4.99%. Mid-capindices have greater exposure to cyclical sectors such asconsumer discretionary.

Expected emphasis on quality The markets earlyrecovery has decidedly favored low-quality stocksthat suffered severely during the downturn; however,it is generally agreed that over longer time periods,quality stocks prevail. This is good news for active fundmanagers, many of whom have lagged their benchmarksbecause of quality-based investment parameters.

Escalating Mergers and Acquisitions activity Asvaluations improve and credit markets loosen, M&A

activity may increase. Growing M&A activity hashistorically benefited the mid-cap sector; mid-capcompanies have been popular acquisition targets andhave often sold at a premium.

PG 6

WHY MID-CAP?


When expected volatility rises mid-caps have generallyoutperformed small caps

March 2009 signaled the transition from recessionto expansion

Investor appetite for risk improved in 2009

0

20

40

60

80

100

120

140

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2CBOE Market Volatility Index - Price IndexRussell Midcap - Index / Russell Top 2000

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

VolatilityIndex

RateofRussellMidcaptoRussell2000


7/8

With these factors at play, we believe that investors shouldbenefit from an allocation to mid-cap stocks. Not only willan allocation to mid-caps help diversify investor portfolios,but it has proven to improve returns with only minimaladditional risk. Exhibit 9 illustrates the benefit of making

an allocation to mid-caps. The incremental benefit ofadding up to a 40% allocation to mid-caps has been greatover longer time periods. Portfolios with higher allocations

to mid-caps experienced the greatest benefit.While investors allocations to mid-cap should be consistentwith their risk tolerance, including a mid-cap allocation hashistorically resulted in improved portfolio performance with

a minimal increase in risk. Reallocating from large caps tomid-caps has improved the diversification of the portfolioand resulted in better risk-adjusted returns.

RETURNS AS OF 12/31/09 (%)

1 year 24.95 27.31 28.90 31.29

3 year -5.62 -5.44 -5.33 -5.17

5 year 0.31 0.67 0.90 1.24

10 year -0.98 0.11 0.83 1.90

STANDARD DEVIATION (%)

1 year 28.77 29.91 30.75 32.11

3 year 19.45 20.26 20.83 21.74

5 year 16.54 17.26 17.77 18.59

10 year 16.47 16.99 17.39 18.07

Conclusion

While the market faces many headwinds mainly in theform of weak employment, high levels of consumer debt and

the likelihood of higher taxes - we are cautiously optimisticabout the continuing economic recovery. In 2010, we believemany investors who were sitting on the sidelines in 2009in low yielding money market funds will begin to movecautiously back into the equity markets as a result of an

increased appetite for risk.

Investors who are ready to re-enter the equity markets maybe well served by adding an allocation to mid-caps as partof a diversified portfolio because mid-caps have had:

1. Consistent outperformance relative to large caps andsmall caps

2. A better risk-reward profile than other market cap sizes

3. Less extreme behavior under changing economicconditions

4. Favorable characteristics regardless of economic

environment

We believe that an analysis of mid-caps relative to othecapitalization segments reveals the continuing strength ofmid-caps as part of a diversified investment portfolio.

PG 7

WHY MID-CAP?


EXHIBIT 9: Comparison of Return and Risk for Mid-Cap Allocations Scenarios

Portfolio 1

Large Cap 80%Small Cap 20%Mid-Cap 0%

Portfolio 2


Portfolio 3


Portfolio 4


Source: Frank Russell Co. (Morningstar, Inc.) as of 12/31/09

Adding up to a 40% allocation of mid-caps can improvereturns with only minimal additional risk

Investors allocations to mid-caps should be consistentwith their risk tolerance


8/8

About Ridgeworth InvestmentsRidgeWorth serves as a money management holdingcompany with eight style-specific institutional investment

management boutiques, each with a well-defined,proven approach and all with unwavering commitmentsto exceptional performance. Through our multiple,style-specific boutiques, we offer a wide range of equity,alternative, fixed income and liquidity managementinvestment disciplines

RidgeWorth Investments, an investment adviserregistered with the SEC since 1985, is headquartered

in Atlanta, Georgia.

Investment ConsiderationsEquity securities (stocks) are more volatile and carrymore risk than other forms of investments, includinginvestments in high grade fixed income securities.

Mid capitalization funds typically carry additional risks since

smaller companies generally have a higher risk of failure.

DefinitionsRussell 3000 Index measures the performance ofthe largest 3000 U.S. companies representing

approximately 98% of the investable U.S. equity market.Russell 1000 Index measures the performance of thelarge cap segment of the U.S. equity universe, representingapproximately 92% of the U.S. market.

Russell Top 200 Index is the mega cap index of the verylargest 200 stocks in the Russell 3000 Index.

Russell Midcap Index measures the performance of themid-cap segment of the U.S. equity universe, representingapproximately 27% of the total market capitalization ofthe Russell 1000 companies.

Russell 2500 Index measures the performance of the

small to mid-cap segment of the U.S. equity universe,commonly referred to as smid cap. It representsapproximately 2500 of the smallest securities.

Russell 2000 Index measures the performance ofthe small cap segment of the U.S. equity universe,representing approximately 8% of the total marketcapitalization of that index.

S&P 500 Index is an unmanaged index of 500 selectedcommon large capitalization stocks (most of which arelisted on the New York Stock Exchange) that is often usedas a measure of the U.S. stock market.

Sharpe Ratio is a risk-adjusted measure that is calculatedusing standard deviation and excess return to determinereward per unit of risk. The higher the Sharpe Ratio, thebetter the funds historical risk-adjusted performance

Upside/Downside Capture Ratio is a measure of risk andillustrates the difference in return of the portfolio and the

underlying benchmark during an up and down market,respectively.

Important InformationThis paper reflects the analysis and opinions ofRidgeWorth Investments as of March 2010. Becausemarket and economic conditions are often subject to rapidchange, the analysis and opinions provided may changewithout notice. The analysis and opinions may not be relied

upon as investment advice.

Statements of fact are from sources consideredreliable but no representation or warranty is made asto their completeness or accuracy. Although historicalperformance is no guarantee of future results, theseinsights may help you understand our investmentmanagement philosophy.

In preparing this paper, we have relied upon andassumed, without independent verification, the accuracyand completeness of all information available from

reliable sources.

PG 8

WHY MID-CAP?


An investor should consider the funds investment objectives, risks, and charges and expenses carefully before investing or

sending money. This and other important information about the RidgeWorth Funds can be found in the funds prospectus. To obtain

a prospectus, please call 1-888-784-3863 or visit www.ridgeworth.com. Please read the prospectus carefully before investing.

2010 RidgeWorth Funds. RidgeWorth Funds are distributed by RidgeWorth Distributors LLC. RidgeWorth Investments is the trade

name for RidgeWorth Capital Management, Inc., the adviser to the RidgeWorth Funds, and is not afliated with the distributor.

Not FDIC Insured No Bank Guarantee May Lose Value

RFWP-MC-03

why mid-cap? white paper - mar 2010

Documents