Planning and Investing Be wary of unintended small- and mid-cap exposure

Potential sources of unintended SMID

Definitions of small- and mid-cap stocks can vary. Morningstar defines large-cap as stocks that together account for the top 70% of the capitalization of the relevant market, mid-cap stocks represent the next 20%, with small-cap stocks making up the balance.

There are several potential sources of unintended SMID exposure. Indexes labeled mid-cap may have significant small-cap exposure, while active funds can have a wide range of SMID allocations even within the same Morningstar category.

One potential cause of unintentional SMID exposure is overlapping capitalizations in different index exchange-traded funds (ETFs). The iShares Core S&P 500 ETF has 81% large-cap and 19% SMID, as one may expect. But the SPDR Portfolio S&P MidCap 400 ETF is significantly more small-cap (72%) than it is mid-cap (almost 27%), while the SPDR Portfolio S&P 600 Small Cap ETF is almost entirely small. So, if an advisor allocates to a mid-cap fund for mid-cap exposure, then a separate small-cap fund for small-cap exposure, the portfolio may end up with more small-cap than the advisor intended. Generally, mid-cap stocks are more volatile than large-cap stocks but less volatile than small-cap stocks.

An advisor concerned about the concentration of the S&P 500 may switch to an equal weighting of S&P companies. That will address concentration risk, but many of the S&P 500 companies are mid-cap. Market weighting gives you 18% mid-cap exposure, but equal weighting gives you far higher.

Even within the same Morningstar category, there can be a wide range of SMID exposures among active equity funds. The chart below plots the range of market-cap exposures among the 25 largest actively managed large-cap growth funds by assets. Although billed as “large cap,” one of the funds had 21% of its assets in SMID, including 6% in small-cap stocks. 

Another potential cause of unintentional SMID exposure are ETFs dedicated to specific niches or sectors with significant exposure to SMID. Roughly one quarter of the advisor portfolios we analyzed included sector-specific allocations. Certain sectors have higher SMID exposure than others. As of June 30, 2025, within the S&P 500 index, the real estate, equity precious metals, energy limited partnerships and utilities sectors each had more than two-thirds exposure to SMID, compared with communications, which had only 18% SMID exposure. It’s important to consider the SMID exposure of industry-specific strategies within the entire portfolio to avoid an unintended allocation to SMID.

These hidden sources of SMID can easily push the portfolio’s SMID exposure above what an advisor envisioned. For example, the Vanguard Total Stock Market ETF — which seeks to represent 100% of the U.S. investable equity market — is around 70% large/30% SMID. So, with actual average exposures of 33%, some advisors are already skewing overweight toward SMID, even without considering differences in portfolio objectives.

What’s the right amount of SMID for your goals?

SMID can play a valuable role in a portfolio depending on the investor’s objective and risk tolerance. For example, a sizable SMID exposure may be appropriate for a growth-oriented portfolio for investors who can tolerate higher volatility in pursuit of outsized returns. However, a high SMID allocation may not be right for a growth-and-income portfolio designed to have more moderate volatility.

Our analysis of advisor portfolios shows that some do not vary SMID exposure based on the portfolio’s objective. For example, advisors’ growth-and-income portfolios tend to have greater SMID exposure than Capital Group’s growth-and-income model portfolio. SMID exposure isn’t necessarily inappropriate for a more income-oriented model, but it’s vital that this exposure is purposeful and is helping to meet the portfolio objective.

An intentional SMID allocation can play a valuable role in a portfolio

For growth-oriented investors, SMID stocks can offer a higher potential for return. In addition, small-cap equities tend to have low correlation to their large-cap counter parts: Over the five years ended June 30, 2025, the Russell 2000 Index had a 0.83 correlation to the S&P 500. Different market environments may favor SMID stocks. For example, SMID stocks often benefit from declining interest rates and a broadening stock market. And many U.S. SMID companies may be less vulnerable to tariffs because the firms derive most of their revenue domestically.

For Capital Group portfolios, the Capital Solutions Group (CSG) finds that SMID exposure can provide a valuable building block for portfolio construction. The asset class tends to be pro-cyclical and do well in recovery and expansionary phases of the business cycle, low-to-falling rates and inflation.

With Capital Group’s focus on objective-based models, SMID holdings can serve a role primarily in capital-appreciation-focused portfolios. Given the cyclical nature of the asset class, a longer time horizon is required to fully capture the upside potential, with characteristics of higher risk and return, and higher volatility less suitable for portfolios with a capital-preservation objective. As a secondary role, it can act as a diversifier of sources of returns alongside large-cap exposure.

As a diversifier, the U.S. small- and mid-cap universe is much less concentrated in top holdings than U.S. large caps. Although the top 10 holdings represent less than 10% of the small- and mid-cap benchmarks, the S&P 500 concentration is reaching historic highs. The SMID universe is also less concentrated across sectors versus U.S. large caps.

Intentional SMID exposure can be a valuable component of many portfolios, but unintentional exposure has the potential to increase portfolio volatility to an uncomfortable level. Review your portfolios at regular intervals to ensure that the market-cap exposure is consistent with the client’s investment objectives.