Why is mid-cap "the sweet spot"?

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Why is mid-cap "the sweet spot"?

Post by oldcomputerguy » Wed Aug 31, 2016 10:18 am

In some of the stuff I've encountered in my reading, I've seen mid-cap equity referred to as "the sweet spot" of investing. I'm just curious why it would be categorized as such. What is it about mid-cap in particular that makes it "sweet"?
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Re: Why is mid-cap "the sweet spot"?

Post by Christine_NM » Wed Aug 31, 2016 10:26 am

My Roth is 100% midcap blend. I like VIMAX because there is less volatility than small caps, which have long periods of underperformance, and also less volatility than the S&P 500, which is a yoyo responding to constant news and noise.

Usually lower volatility means less return, but iirc with midcaps the return is slightly higher in recent years (since 2000) than the overall market.

It has been doing well lately so buying now is not much of a bargain.

These are just my impressions, I have not made a statistical study of midcaps vs. the total market.
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Re: Why is mid-cap "the sweet spot"?

Post by slayed » Wed Aug 31, 2016 10:29 am


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Re: Why is mid-cap "the sweet spot"?

Post by livesoft » Wed Aug 31, 2016 11:53 am

It is a just bathroom humor. Mid-caps are not really the sweet spot of anything.
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Re: Why is mid-cap "the sweet spot"?

Post by lack_ey » Wed Aug 31, 2016 12:13 pm

Christine_NM wrote:My Roth is 100% midcap blend. I like VIMAX because there is less volatility than small caps, which have long periods of underperformance, and also less volatility than the S&P 500, which is a yoyo responding to constant news and noise.

Usually lower volatility means less return, but iirc with midcaps the return is slightly higher in recent years (since 2000) than the overall market.

It has been doing well lately so buying now is not much of a bargain.

These are just my impressions, I have not made a statistical study of midcaps vs. the total market.

I don't think the impression is correct generally or in the period given. Mid caps should usually be more volatile than the S&P 500.

Vanguard's index funds changed indexes over the period, but just looking at their returns, I don't see evidence of lower volatility:
Image
https://www.portfoliovisualizer.com/bac ... Blend3=100

Most of the market is large caps. Mid caps are tilted to small, relatively speaking, compared to the total market, and the size effect historically was relatively monotonic: larger meant lower risk and lower return, up and down the size scale.

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Re: Why is mid-cap "the sweet spot"?

Post by Christine_NM » Wed Aug 31, 2016 12:23 pm

^^^ Thanks for the official numbers, esp. SD. I formed my impression by days that I happen to compare index values over the years, not by monthly or annualized SDs. I hope it will be a long time before the world gives up on large and small and overbuys midcaps.
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Re: Why is mid-cap "the sweet spot"?

Post by wilson08 » Wed Aug 31, 2016 5:02 pm

In this article the midcap "sweet spot" is defined quite well I think.

https://www.tiaa.org/public/pdf/inv_ins ... 022812.pdf

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Re: Why is mid-cap "the sweet spot"?

Post by oldcomputerguy » Wed Aug 31, 2016 5:09 pm

wilson08 wrote:In this article the midcap "sweet spot" is defined quite well I think.

https://www.tiaa.org/public/pdf/inv_ins ... 022812.pdf


Interesting read. Thanks.
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Re: Why is mid-cap "the sweet spot"?

Post by Rick Ferri » Wed Aug 31, 2016 5:24 pm

There is no "free lunch" at Wall Street's mid cap counter. Investing just isn't that easy. The higher returns come with higher risk. This risk isn't apparent all the time, but that doesn't mean it's not there.
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Re: Why is mid-cap "the sweet spot"?

Post by Kevin M » Wed Aug 31, 2016 7:27 pm

In my opinion this is a myth, especially if you look at the performance of Vanguard funds.

If you use PortfolioVisualizer to compare large-cap, mid-cap, and small-cap -asset classes from 1972-2015, mid-caps look like they performed somewhere between small-cap and large-cap until about 1989, as you might expect. But after that the performance of mid-caps looks a lot closer to that of small-caps--there's a big gap between small/mid and large, but not much daylight between small and mid. Note that proxies are used for the older data before Vanguard funds were available for a particular asset class. Backtest Portfolio Asset Class Allocation

If you use actual Vanguard funds, you can look at performance since Jan 1999: Backtest Portfolio Asset Allocation. From this comparison it is even more clear that both returns and volatility for the mid-cap fund are much more similar to that of the small-cap fund than to the large-cap 500 Index fund.

This is why I've said many times that I would happily use the Vanguard mid-cap fund as a substitute for small-cap if, for example, the mid-cap fund was available in my 401k or 403b, but it would be extremely imprudent to use the Vanguard mid-cap fund as a substitute for a large-cap fund, since the risk and return will much more closely resemble the Vanguard small-cap fund.

Also, although the mid-cap fund has outperformed the small-cap fund over the entire period from Jan 1999 through July 2016, this kind of thing is highly dependent on start and end points. If you shift the start point about three years forward, to April 2002, the gap between small-cap and mid-cap essentially disappears. Backtest Portfolio Asset Allocation. With a little more sleuthing you can track down most of the outperformance of the mid-cap fund to just July and August of 2000, so not a very robust data set for the superiority of mid-cap over small-cap. Although the standard deviation of monthly returns of the mid-cap fund is pretty consistently a bit lower than the small-cap fund, I don't think you can really see that on a chart, but you can see the higher volatility of the small-cap and mid-cap funds compared to a large-cap fund.

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Re: Why is mid-cap "the sweet spot"?

Post by Mel Lindauer » Wed Aug 31, 2016 7:43 pm

For those inclined to slice-and-dice, consider 100% mid-caps instead of the usual recommended allocation of 50% large and 50% small.

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Re: Why is mid-cap "the sweet spot"?

Post by carolinaman » Thu Sep 01, 2016 8:10 am

One rationale I have heard is that mid caps are less risky than small caps. They have survived small cap status and are more stable than SC. As compared to SC, they have less risk and less upside. As compared to LC, they have more risk and more upside or so the theory goes. They fit between SC and LC based on risk and opportunity. Apparently this did not show up in the data analysis KevinM did as MC seems very comparable to SC.

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Re: Why is mid-cap "the sweet spot"?

Post by Kevin M » Thu Sep 01, 2016 9:38 am

Mel Lindauer wrote:For those inclined to slice-and-dice, consider 100% mid-caps instead of the usual recommended allocation of 50% large and 50% small.

Hi Mel,

This appears to have made sense until perhaps as late as 1999, but if you look at 1999 to date, when you could actually do this with Vanguard funds (VG mid-cap introduced mid-1998), it has not worked out as you would expect: Backtest Portfolio Asset Class Allocation.

For those who bother to click on the link, the blue line is 50/50 large/small, red is 100% mid-cap, and for additional comparison orange is 50/50 large/mid. Per Mel's suggestion, 100% mid-cap tracked 50/50 large/small pretty well through 1998, but after that it diverged significantly. Consistent with the observations in my previous reply, using actual Vanguard funds from 1999 - 2015, mid-cap performance was very much like small-cap performance, so the best tracking was between 50/50 large/mid and 50/50 small/mid.

To see this even more clearly, using the funds from Sep 2000 - Aug 2016 (to eliminate the unusual performance in Jul-Aug 2000), see this chart: Backtest Portfolio Asset Allocation. Here the blue line once again is 50/50 large/small, but the red line is 100% mid-cap and orange is 100% small-cap. Per previous observations, small-cap and mid-cap track very closely, both diverge wildly from 50/50 large/small, and both beat 50/50 large/small handily, since the small-cap premium paid off over this timeframe.

So if you want to use Vanguard mid-cap fund instead of Vanguard small-cap, history suggests it will work out fine (maybe even a bit better), but history also suggests that using Vanguard mid-cap instead of 50/50 Vanguard large/small is unlikely to work out as you might expect.

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Re: Why is mid-cap "the sweet spot"?

Post by sreynard » Thu Sep 01, 2016 10:04 am

smartinwate wrote:In some of the stuff I've encountered in my reading, I've seen mid-cap equity referred to as "the sweet spot" of investing. I'm just curious why it would be categorized as such. What is it about mid-cap in particular that makes it "sweet"?


That's funny. Mid-caps used to be considered the black abyss of investing. Nobody wanted them. They were too small for large cap funds and too large for small cap funds. They weren't being bid up by everybody trying to time the market, so could languish for years. Which, as a value investor, was what made them "sweet", i.e. their generally lower P/E suggested that they were a good value. :oops:

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Re: Why is mid-cap "the sweet spot"?

Post by Christine_NM » Thu Sep 01, 2016 10:22 am

Midcaps look similar to small on a chart, but the question is why. sreynard is right about pre-internet investing, but now that we have etfs there is no neglected corner of the market.

Let's face it, when the market goes down seriously, all caps fall together. That is the meaning of crash. The risk differential between large/mid/small is trivial compared to the risk of owning equities.

Anyway, while the market is going up, with midcaps you are getting similar-to-smallcap performance for less volatility. Is that not good enough?

Kevin thanks for the PV analysis. Yes, I clicked on the links.
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Re: Why is mid-cap "the sweet spot"?

Post by Kevin M » Thu Sep 01, 2016 11:41 am

Christine_NM wrote:Midcaps look similar to small on a chart, but the question is why

Because the median market cap of mid-cap is much closer to that of small cap than to that of large cap. You can see this if you look at the stock attributes on the Vanguard website:

$85.0 B: 500 Index
$72.9 B: large-cap index
$11.8 B: mid-cap index
$ 3.3 B: small-cap index

If we look at these as ratios, mid-cap is about 14% the size of 500 Index and small-cap is about 4%, so about 70 percentage points between large and mid and only 10 percentage points between mid and small. I think it also has to do with the fact that large-cap is dominated by a relatively few mega-cap stocks. Note that Vanguard large-cap index consists of mega-cap plus mid-cap, so if you carve out the mega-cap you are left with mid-cap.

Christine_NM wrote:Anyway, while the market is going up, with midcaps you are getting similar-to-smallcap performance for less volatility. Is that not good enough?

Yes, as a very nice substitute for small caps, at least historically. If you carve out a few of the anomalous months, mid-caps have about the same performance as small-caps, but no matter what time periods I've looked at, mid-caps consistently have lower monthly volatility (the SD shown on PV is annualized monthly volatility). So in the small/mid-cap universe, mid-caps do indeed seem to be something of a sweet spot, at least when it comes to the Vanguard funds, but this is much different than characterizing them as the sweet spot in the entire stock universe.

My main purpose in these threads (this is far from the first) is to debunk the notion that the risk and return of mid-cap is about in the middle of large-cap and small-cap, which it clearly has not been for Vanguard funds since the introduction of the Vanguard mid-cap fund in mid 1998, other than perhaps for the first year or two.

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Re: Why is mid-cap "the sweet spot"?

Post by LytleJV » Tue Jun 06, 2017 2:37 pm

Two good articles about the Mid-Cap Sweet Spot, BTW I'm a believer. The MDY ETF has existed for more than 20 years ( 1992 ), consider it's performance, or IJH, against alternatives. Don't get me wrong I still believe in small-caps & large cap, but I definitely favor overweighting mid-cap and small-cap value.


https://seekingalpha.com/article/107160 ... y-it-works


https://hennessyfunds.com/resources/doc ... _Paper.pdf
Last edited by LytleJV on Wed Jun 07, 2017 5:57 am, edited 2 times in total.

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Re: Why is mid-cap "the sweet spot"?

Post by SeeMoe » Tue Jun 06, 2017 8:50 pm

"Sweet Spot" is also a golf term for the exact center spot on the face of the golf club to have a perfect strike on the little white golf ball. Pro golfers have this little circle on all of their clubs vs amateurs who have tiny strike marks all over the club face,.....like me.
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Re: Why is mid-cap "the sweet spot"?

Post by Theoretical » Tue Jun 06, 2017 10:14 pm

To me, it's more of a factor of Midcaps not being megacaps that supplies the extra return and risk. The downside is that in an apocalyptic scenario like 2008 or the 1930s, the vast majority of the Microsofts and GEs are going to stick around due to their sheer blue-chippiness. Keep in mind that it's not just tax reasons that these megacorps seem to be sitting on piles of cash. A lot of times, it's because they're so big there's a lot of investments they'll dwarf. But that means when the monsoons come, their stock prices will get hit, but the vast majority will survive and may be able to bottom-feed like Buffett did in 2008.

Midcaps are still big companies, though how big really depends on your definition of midcap. Russell and CSRP gets pretty big. S&P's definition is almost half small cap by many definitions.

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Re: Why is mid-cap "the sweet spot"?

Post by jbranx » Wed Jun 07, 2017 12:01 am

I wonder how much of a factor the "index effect" has been in the S&P Midcap 400. That is, the Index Committee at S&P has generally picked new entrants for the 500 that meet the market cap and quality screens from the 400, and likewise, for the 400 from the 600. Of course, there were/and are many midcaps and smallcaps in the 500. Additionally and importantly, large caps shopping for mergers/acquisitions have kept their eyes on the midcaps.

I don't have any data on the sector weights of the Midcap 400 at launch in 1991, but I have the impression that banks and utilities had a much higher weight than the 500. I do recall the median market cap at the time was $750,000; today it's $3.8 billion.

But the return has to be mainly related to the extra risk. There might also be some additional return that came from the midcaps not having significant foreign revenue/eps exposure.

If there is a sound basis for "sweet spot," it's got to be less risk than smallcaps and higher risk that larger ones. Further, there are fewer futures and options traded on midcaps, raising the issue of whether they are less suspect to becoming overvalued like the large caps. That last is a conjecture and might have applied only in the early days. Following the launch in '91, all the fund companies rushed to roll out a midcap fund. Prior to S&P's entry, the only "midcap" word attached to stocks was a portfolio at American National Bank, one of the index pioneers.

That said, one of the most enduring things about "midcaps" has been that Mel Lindauer has been a consistent champion from day one!!

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Re: Why is mid-cap "the sweet spot"?

Post by NiceUnparticularMan » Wed Jun 07, 2017 5:12 am

So according to Portfolio Visualizer, Vanguard's Midcap Index fund (VIMSX) has had both a small and value loading:

https://www.portfoliovisualizer.com/fac ... sion=false

That explains some but not all of its performance in that period, as it also has a substantial annual alpha of 2.25%.

When I see results like that for funds like this, my immediate thought is we may be looking at some sort of quality screen. To test for that, you can use a five-factor regression instead. And sure enough, the alpha drops a whole bunch, to 0.59%:

https://www.portfoliovisualizer.com/fac ... bol2=VTSMX

Even that amount of residual alpha is a pretty big anomaly, but I'd still say we have at least explained a good chunk of what was going on with VIMSX--it was a mildly small and mildly value fund with a quite effective quality screen.

Edit: Same tests for MDY, but now I can go back earlier to September 1995 instead of just June 1998:

Three-factor regression indicates a somewhat higher small and value exposure with bit lower but still significant alpha of 1.11%:

https://www.portfoliovisualizer.com/fac ... sion=false

OK, so checking the five-factor regression we entirely eliminate the alpha (it is now -0.08%):

https://www.portfoliovisualizer.com/fac ... sion=false

My conclusion is therefore the same but even more so--MDY was getting you a somewhat small, somewhat valuey fund with an effective quality screen (and maybe that is all--but that is a lot).

You can look at MDY back to June 1998, and you get three-factor alpha of 2.05% and five-factor alpha of 0.59%:

https://www.portfoliovisualizer.com/fac ... sion=false

https://www.portfoliovisualizer.com/fac ... sion=false

I've now got a guess here that the dot-com era is creating some of this residual alpha. To test that, I am going to move forward to October 2002, when the SP500 hits bottom during the dot-com bust.

For MDY, the three-factor alpha goes down to 0.36%, and the five-factor alpha is 0.11%. Note also the value loading has disappeared:

https://www.portfoliovisualizer.com/fac ... sion=false

https://www.portfoliovisualizer.com/fac ... sion=false

Still a quality screen, but milder benefits.

For VIMSX, it is 0.09% and -0.01%, and again the value loading is gone:

https://www.portfoliovisualizer.com/fac ... sion=false

https://www.portfoliovisualizer.com/fac ... sion=false

That's barely any help at all anymore.

OK, so conclusions: looks like in the dot com era, these midcap funds basically had small, value, and quality characteristics that helped them dodge the dot com bust. Since then they are more just what you would expect, meaning mildly small funds, maybe with just a little quality screening too.

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Re: Why is mid-cap "the sweet spot"?

Post by dcabler » Wed Jun 07, 2017 9:24 am

Heavy Mid-capper here. Not sure about "sweet spot", but what I've found is that most of the time, mid caps do roughly as well as TSM (or close enough for me). But, like small caps, they tend to do better than TSM coming out of a recession/bear market. So excess returns, when they happen, tend to happen in bursts.

Now there are midcaps and there are midcaps. Every index seems to have its own definition as does Morningstar when you try to compare things. So there will be a dispersion in returns across different indices. And as others have pointed out, some fund companies have switched indices over time. My personal preference is to make a pseudo-backtest using whatever index is currently in use by a fund/ETF as if that had been the index used by the fund/ETF all along. But that's just me - I like to play with spreadsheets. :D

You can go to this wiki and see returns from various indices that call themselves midcap. It will show blend, value and growth indices.
https://www.bogleheads.org/wiki/US_mid_ ... ex_returns

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Re: Why is mid-cap "the sweet spot"?

Post by Kevin M » Wed Jun 07, 2017 11:15 am

NiceUnparticularMan wrote: OK, so conclusions: looks like in the dot com era, these midcap funds basically had small, value, and quality characteristics that helped them dodge the dot com bust. Since then they are more just what you would expect, meaning mildly small funds, maybe with just a little quality screening too.
Lots more analysis on the "why", but basically the same conclusion about the "what" that I found long ago, have posted about numerous times in other threads on this topic, and summarized in an earlier reply in this thread:
Kevin M wrote: Also, although the mid-cap fund has outperformed the small-cap fund over the entire period from Jan 1999 through July 2016, this kind of thing is highly dependent on start and end points. If you shift the start point about three years forward, to April 2002, the gap between small-cap and mid-cap essentially disappears. Backtest Portfolio Asset Allocation. With a little more sleuthing you can track down most of the outperformance of the mid-cap fund to just July and August of 2000, so not a very robust data set for the superiority of mid-cap over small-cap.
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Re: Why is mid-cap "the sweet spot"?

Post by NiceUnparticularMan » Wed Jun 07, 2017 11:47 am

Kevin M wrote:
NiceUnparticularMan wrote: OK, so conclusions: looks like in the dot com era, these midcap funds basically had small, value, and quality characteristics that helped them dodge the dot com bust. Since then they are more just what you would expect, meaning mildly small funds, maybe with just a little quality screening too.
Lots more analysis on the "why", but basically the same conclusion about the "what" that I found long ago, have posted about numerous times in other threads on this topic, and summarized in an earlier reply in this thread:
Kevin M wrote: Also, although the mid-cap fund has outperformed the small-cap fund over the entire period from Jan 1999 through July 2016, this kind of thing is highly dependent on start and end points. If you shift the start point about three years forward, to April 2002, the gap between small-cap and mid-cap essentially disappears. Backtest Portfolio Asset Allocation. With a little more sleuthing you can track down most of the outperformance of the mid-cap fund to just July and August of 2000, so not a very robust data set for the superiority of mid-cap over small-cap.
Kevin
I agree, that seems like the same basic result.

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Re: Why is mid-cap "the sweet spot"?

Post by nisiprius » Wed Jun 07, 2017 2:03 pm

oldcomputerguy wrote:In some of the stuff I've encountered in my reading, I've seen mid-cap equity referred to as "the sweet spot" of investing. I'm just curious why it would be categorized as such.
Marketing.

Admittedly I'm hardly tuned into Wall Street, but the first time I ever heard mid-caps called "the sweet spot" was in a series of ads by SSgA. This one is from 2006 but they were running them much earlier.

Image

If someone can show me a quotation from a finance article before SSgA's ads that called mid-caps "the sweet spot of the market" I will be enlightened and stand corrected.

Don't try to figure out what it means. It doesn't mean anything. That's exactly why it's a good advertising slogan for a financial product. If it meant something, then it might not be true and somebody could complain. This ad is a marvel of careful wordsmithing. They say things that a simple facts (like "this mid-cap ETF lets you buy mid-caps"). And then they also say something which is true and means something, but isn't any particular reason to buy:
While mid-caps securities are subject to greater risks than large-caps, mid-caps are less volatile than companies in the often uncertain start-up phase.
Yeah, because they're smaller than large-caps and larger than small-caps.

Notice, too "you're considering... a different balance of upside potential and risk." They said different; you might think you heard better, but they didn't say it.
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Re: Why is mid-cap "the sweet spot"?

Post by Kevin M » Wed Jun 07, 2017 2:44 pm

nisiprius wrote: If someone can show me a quotation from a finance article before SSgA's ads that called mid-caps "the sweet spot of the market" I will be enlightened and stand corrected.
I don't know about a "finance article", but I believe Mel has been using the sweet spot terminology to characterize mid-caps since long before 2006. Here's a link to a 2004 M* forum thread in which he uses the term: Mel's Unloved Mid-Caps Update - indexes, newsletter, Mid Cap, mid-cap, large cap blend.

Of course as the post title indicates, "Mel's unloved mid-caps" is the terminology more frequently associated with Mel and midcaps.

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Re: Why is mid-cap "the sweet spot"?

Post by bayview » Wed Jun 07, 2017 6:18 pm

We hold some VIMAX (midcap blend) simply because of nervousness about the top-heaviness of TSM with so few companies, especially the techs:

Month-end ten largest holdings as of 04/30/2017 (VTSAX)
Rank Holdings
1 Apple Inc.
2 Alphabet Inc.
3 Microsoft Corp.
4 Amazon.com Inc.
5 Facebook Inc.
6 Exxon Mobil Corp.
7 Johnson & Johnson
8 Berkshire Hathaway Inc.
9 JPMorgan Chase & Co.
10 General Electric Co.
Ten largest holdings = 16.4% of total net assets
(emphasis mine)

That's ten companies out of 3,575 accounting for 1/6 of VTSAX's entire holdings.

If someone would create a TSM minus the top ten companies (top five would be better), I might be interested. :D I'd certainly continue to hold TSM, but I sure would like a bit less exposure to the monsters.

Edit to add: and VIMAX has certainly held its own in the relatively short time that we've had it.
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