Brenton Saunders: How ASX midcaps can help diversify portfolios away from banks and miners

ASX midcaps offer an important alternative for investors concerned about high prices and low growth offered by banks and miners. Pendal portfolio manager BRENTON SAUNDERS explains

• ASX earnings season sell-offs expose large-cap concentration risk
• Midcaps spread risk and offer broader growth drivers
• Find out about Pendal MidCap Fund

ASX-listed midcap stocks can help investors diversify portfolios away from the handful of mega-caps and banks that dominate Australia’s sharemarket, says Pendal portfolio manager Brenton Saunders.

The latest reporting season demonstrates how large-cap investors are exposed to sell-offs, after Commonwealth Bank of Australia and CSL dragged down the broader market.

These sell-offs demonstrate concentration risk on the ASX, where index weightings are dominated by a few large companies, notably the banks and miners, leaving investors vulnerable when sentiment turns against them.

By contrast, the midcap index has outperformed large caps so far this year, reflecting a more diverse range of growth drivers with no dominant stocks or sectors.

“Midcaps should be seen as a real alternative to the traditional large-cap/small-cap mix most advisers and allocators normally follow,” Saunders says.

Saunders is the portfolio manager of the Pendal MidCap fund, which invests in the 100 largest companies outside the top 50.

The large-cap challenge

Saunders says the strong market reaction to results from Commonwealth Bank and CSL this reporting season demonstrates investor nervousness with highly rated, lower-growth large caps.

“CBA and CSL have come in for heavy selling despite delivering reasonable results,” he says.

“The market is nervous about some of these very highly rated large caps and that is dragging down their sectors and the large cap indices.”

Big companies like the banks and CSL face twin challenges, he says.

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They are mature businesses which have grown to dominate their markets, leaving them with lower potential growth.

But despite this slower earnings growth, investors still value them as if they can deliver strong growth in future.

The market has been paying up for earnings certainty, despite these companies having modest earnings growth. When earnings disappoint, the reactions to these highly rated stocks are more extreme.

This risk remains with the banking sector trading at close to 4 standard deviations above its long run PE.

Share prices for the large miners like BHP, Rio Tinto and Fortescue held up better through reporting season but fundamentals remain constrained without a large Chinese stimulus package, he says.

China remains the biggest buyer of Australian metals but under Xi Jinping has been avoiding the kind of sweeping, large-scale infrastructure stimulus needed to lift demand.

Why midcaps are different

Focusing on midcaps would have allowed investors to avoid being dragged down by heavy sell-offs in a few mega caps during reporting season – as well as avoid being overexposed to large, mature companies with limited growth but high valuations.

In the ASX 300, just 18 companies have more than a 1 per cent weighting in the index, yet those 18 account for more than half of the index, says Saunders.

Banks dominate – making up almost a quarter of index, with CBA counting for 10 per cent of the index by itself.

That means if banks are sold off, the entire index will be dragged down.

In effect, an investor holding the ASX300 or similar ETF is making a large bet on a very small group of mega caps – whether they intend to or not, says Saunders.

Midcaps look very different.

In Pendal’s Midcap benchmark, covering companies ranked 51 to 150 on the ASX, 37 companies carry more than a 1 per cent weighting. The top 18 names account for just 37 per cent of the benchmark, and the largest stock is just 2.8 per cent, says Saunders.

Banks together represent about 3 per cent, and iron ore exposure is only 0.4 per cent.

That means no single stock is large enough to dictate performance.

 “We’ve got more ability to find opportunities and to be less benchmark-focused” says Saunders.

“It’s fundamentally different to the large-cap benchmarks – very different.”

How midcaps perform

This index difference has shown up in performance.

So far this year, the ASX midcap index (ASX 50–100) is ahead of the ASX 200 by 6.2 percentage points and in line with the Small Ordinaries smallcap index despite having lower volatility risk.

Pendal’s own MidCap strategy has delivered another 3-4 percent above that, says Saunders.

Quality filters

Saunders says it’s important that investors in midcaps take a discriminating approach to the sector and select the companies in the sweet spot of their business evolution that make Midcaps an attractive area.

“Passive products and ETFs that track the ASX Mids Index are restricted to the ASX 50–100 and offer fewer strong investment ideas. For example in the first half of 2025, the index included only one gold producer, Evolution Mining.

“Pendal’s broader benchmark, which includes stocks ranked 51-150, had up to seven. “That broader opportunity set gave Pendal more room to find winners, and its gold exposure was an important contributor to returns.”