Why We Believe SMID Cap Core Can Beat Separate Small & Mid Allocations
Many investors instinctively split their equity sleeve into a “small-cap fund” and a “mid-cap fund,” assuming that specialization unlocks performance. It feels neat… tidy. But that separation often comes with hidden costs: timing mismatches, forced rebalances, duplication of exposures, and blind spots through transitions.
At City Different, we believe there’s a better way. Our SMID Cap Core strategy is designed not to chase size buckets, but to invest across the full business life cycle — from early emerging companies to mature names — all in one disciplined, focused portfolio.
Here’s our case for why we think SMID Cap Core offers a more coherent, flexible, and potentially more durable framework than separate small-cap + mid-cap allocations.
The limitations of siloed allocations
- Arbitrary “buckets” force unnatural behavior
When a stock “graduates” from small to mid, it often triggers a forced sell in the small-cap sleeve and a buy in the mid-cap sleeve. That handoff can occur at valuations or times that are suboptimal (potentially cutting off upside precisely when the business is entering its strongest growth period).
- Exposure overlap + duplication
To avoid style drift or unintended bets, many managers hedge or preemptively rebalance. But that can lead to duplicated sector or factor exposures across sleeves, increasing complexity without much incremental edge.
- Cycle and regime exposure risks
Small-cap funds tend to capture earlier recovery phases but suffer in drawdowns; mid-cap funds may lag early inflections. Holding them separately means your combined portfolio could oscillate between over-tilts or underexposures depending on which sleeve is “in favor.”
- Transaction friction & rebalancing inefficiencies
Index reconstitution events and migration between buckets can induce trading costs and volatility. For example, the Russell indexes undergo a full reconstitution each June, prompting high turnover as funds align with new breakpoints. LPL notes that in recent years these events can generate sudden volume spikes (billions of dollars of trades in seconds) around key rebalance dates. Earlier studies, such as Madhavan’s analysis of the “Russell Reconstitution Effect,” documented significant return anomalies and trading pressures tied to these index shifts.
That doesn’t mean the effect is overwhelming today (index providers have softened shocks with advance notices and buffer rules), but it remains something to manage and anticipate rather than ignore.
The case for a unified SMID Cap Core
We built our SMID Cap Core strategy to internalize exactly these issues — to invest across size transitions within one disciplined structure rather than fighting against them.
Here’s how:
- Life cycle buckets, not size buckets: We group names into Emerging, Established, and Mature baskets, based on business fundamentals (growth, profitability, competition, capital structure), not just market cap
- Flexibility across the growth curve: When a company transitions from emerging into established, it naturally migrates within our portfolio without triggering abrupt trades or mandate handoffs
- Balanced exposure by design: We maintain meaningful allocations in each basket to smooth performance across regimes, rather than relying on timing or predictions
- Stock selection over blind size bets: We don’t rely on the “size premium” as our base case; rather, we seek mispricing and compelling fundamentals wherever they lie in the growth cycle
Because of that structure, we aim to capture the advantages of small and mid, while moderating the extremes through internal balancing.
What the research tells us (and how it supports the thesis)
- The “mid-cap sweet spot” is real (but incomplete)
Index provider research asserts that mid-cap stocks historically deliver strong risk-adjusted returns relative to both large and small caps. Their whitepaper argues that mid-caps often benefit from enough scale to reduce volatility, yet still retain room for growth — a middle ground many call the “sweet spot.” Similarly, the S&P MidCap 400 index has outperformed comparable small and large benchmarks over long periods.
However, while the “sweet spot” is a compelling anchor, it doesn’t address exposures to emerging disruptors or undervalued mature names (which are places where we’ve seen opportunity in a unified SMID sleeve).
- Small-cap cycles and valuation dynamics argue for balance
Recent commentary from some practitioners highlights that small-cap strategies, while capable of outperformance, face steeper drawdowns and higher volatility, especially during capital stress or rising rates environments. (Morningstar) In certain markets, small-cap underperformance has persisted for extended stretches, making timing difficult. A balanced approach helps avoid overcommitment to one cycle.
- Reconciling size premium with active selection
Academic literature such as Fama & French has long documented size, value, and momentum effects — but also shown that size alone is not a guaranteed alpha source across all regimes. Incorporating that nuance, our approach treats size as a dimension, not a gospel. We believe the real opportunity lies in identifying undervalued names across growth stages, not in mechanistic tilts.
- Frictional costs from reconstitution and migration
The mechanics of index reconstitution — particularly in Russell indexes — induce trading volume and short-term price pressure. Madhavan’s classic work documented abnormal returns associated with these reconstitution events. More modern analyses show that while the impact has dampened, the rebalancing process still matters, especially for portfolios benchmarked to index breaks.
By combining the entire SMID zone internally, our portfolio avoids many of those forced, external transitions and timing chores.
- Information frictions in less-covered names favor active insight
Smaller and mid-tier companies often have thinner coverage, limited analyst followership, or less efficient pricing, creating pockets of inefficiency. Classic work on “the neglected firm effect” supports the idea that lesser-known firms can harbor mispricing because of that thinner coverage. When paired with rigorous due diligence, those opportunities align well with a concentrated, bottom-up strategy.
In short: we don’t claim a mechanical “size premium” — we lean into inefficiencies where they exist, and build a portfolio structure that gives us exposure to them without overexposing to extremes.
Performance & real-world validation
We’ve seen these principles work in practice. As of 3Q25:
- Our SMID Cap Core strategy has outperformed the Russell 2500 over the past three years and since its inception.
- Most of the relative gains stem from stock selection across baskets, not from pure size drift.
- The portfolio’s basket allocations (Emerging, Established, Mature) have delivered differentiated contributions during varying market conditions — providing built-in diversification across regimes.
- We maintain a focused concentration (20-35 names), which enhances our ability to lean into high-conviction ideas across the growth spectrum.
These results don’t guarantee future success, of course — but they reinforce the logic that a unified approach can harness the best of both small and mid without being hemmed in by structural limitations.
Parting Shots
- Having separate small- and mid-cap sleeves may sound clean and specialized, but it introduces structural risks (things like forced trades, mismatches, redundant exposure, and inter-sleeve timing tension)
- The “mid-cap sweet spot” is credible, but only captures part of the opportunity landscape. A true lifecycle approach gives you that zone plus access to earlier-stage disruptors and disciplined mature value plays
- Our SMID Cap Core portfolio is built to internalize transitions, maintain balance, and emphasize selection over mechanical tilts
While reconstitution friction and valuation cycles exist, we believe a unified structure gives us more control and coherence (and helps us stay invested in what matters, not in slicing exposure by size)
IMPORTANT DISCLOSURES
The information and statistics contained in this communication have been obtained from sources we believe to be reliable but cannot be guaranteed. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and are subject to change without notice. Any projections, market outlooks or forecasts discussed herein are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. Please remember that past performance may not be indicative of future results.
The objective of the City Different SMID Cap Core strategy is to generate strong risk-adjusted returns in a focused portfolio of small and mid-cap stocks invested across the business life cycle. Portfolios invest primarily in U.S. stocks with greater than $100 million in market cap. Portfolios typically hold between 20-35 positions, with no position representing more than 10% of the portfolio at time of purchase. Not less than 80% of portfolio assets will be invested in companies whose market cap is within the market cap range of the Russell 2500 Index. The strategy may take on international exposure up to 25% of portfolio assets. An investment in the strategy is subject to certain risks. The value of an investment may fall as well as rise and is not guaranteed. Equities may decline in value due to both real and perceived general market, economic and industry conditions.
The Russell 2500 Index measures the performance of the small to midcap segment of the US equity universe, commonly referred to as "smid" cap. The Russell 2500™ Index is a subset of the Russell 3000® Index. It includes approximately 2500 of the smallest securities based on a combination of their market cap and current index membership.
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