Why Mid-Caps Stand Out in This Slow-Growth Stretch

An upbeat outlook for earnings among midsized companies.

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Some fund managers argue that "stuck in the middle" isn't being stuck at all, at least when it comes to the mid-cap stocks they think will outperform during a predicted period of slow economic growth.

There's some history that backs that view. "Mid-cap has outperformed large- and small-cap going back 10, 15, even 20 years," says Y. Allen Kim of Genworth Financial Asset Management. "We think it's the real sweet spot of the market to be in."

[See top-rated funds by category ranked by U.S. News Mutual Fund Score.]

Mid-cap proponents are making their case based on an upbeat outlook for earnings. Plus, nimbler mid-cap companies should experience stronger growth than their large-cap brethren as the U.S. economy ticks along at between a 1 percent and 2 percent GDP growth rate in 2012. Mid-caps are often acquisition targets of larger firms hungry for expansion.

In addition, attractive valuation on a case-by-case basis among mid-cap stocks can be found since analysts and investors tend to pay less attention to the group than widely tracked large-caps and headline-grabbing—and typically volatile—small-cap growth companies.

"It's hard for large-caps to achieve incremental growth. Mid-caps are in the earlier part of their life cycle and so can achieve better growth," says Michelle Clayman, co-manager of the Calvert Capital Accumulation Fund (CCAFX).

"But relative to small-caps, they've gotten through those early entrepreneurial steps and have transitioned to professional management. Plus, their stock prices tend to show less volatility," says Clayman, whose fund was up nearly 3 percent year-to-date through mid-December.

[See Why Mutual Funds Make Sense in a Volatile Market.]

Calvert defines mid-cap as stocks with a market capitalization of $1 billion to $9 billion at the time of purchase. Morningstar uses a range of $1 billion to $8 billion, and some prospectuses even stretch the upper end to $10 billion. Market cap is calculated by multiplying a company's shares outstanding by the current market price of one share. This figure is generally used in determining a company's size, as opposed to sales or total asset figures.

The chance that a buyout will boost share value adds to the appeal of mid-caps. For certain, a buildup of company cash over the past few years has turned many a board into opportune buyers. That's a positive factor for investors.

Clayman expects positive revenue growth for much of the sector. Still, risk lies in the difficulty that U.S. firms may have in sustaining incremental productivity growth, she says.

Investors will also want to distinguish between value mid-caps and growth mid-caps.

[See 5 Ways to Measure Investment Risk.]

In his report on the Vanguard Mid-Cap Value ETF (VOE), Morningstar analyst Michael Rawson notes that smaller stocks and value stocks tend to outperform over time, although they can require a long time horizon to get there. "For portfolios with huge stakes in large-cap growth companies, value ETFs such as this one can provide a low-cost counterbalance to decrease overall volatility," he adds.

Genworth's Kim also stresses the importance of a diversified portfolio and likes to layer in mid-caps for a "return-enhancing complimentary addition to an existing large-cap allocation."

Here are the top-ranked mid-cap growth and mid-cap value funds tracked by U.S. News:

Growth

Delaware Pooled Focus Mid Cap Growth Equity Fund (DCGTX): Up 17.8 percent over the past year; Expenses: 0.92 percent

Chase Mid Cap Growth Fund (CHAMX): Up 20.8 percent over the past year; Expenses: 1.49 percent

Delaware Select Growth Fund (DVEAX): Up 16.7 percent over the past year; Expenses: 1.49 percent

Royce Premier Fund (RYPRX): Up 12 percent over the past year; Expenses 1.12 percent

Wasatch Heritage Growth Fund (WAHGX): Up 10.5 percent over the past year; Expenses: 0.95 percent

Value

Appleseed Fund (APPLX): Up 5.8 percent over the past year; Expenses: 1.31 percent

Artisan Mid Cap Value Fund (ARTQX): Up 12 percent over the past year; Expenses 1.21 percent