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Portfolio > Mutual Funds

High Noon for Mid-Caps?

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Mid-cap stocks and mutual funds that invest in them have been on a roll so far this year, but the winning streak may be nearing an end.

Through October, stocks of medium-sized companies had performed better than those of small and large ones, as measured by gauges compiled by Standard & Poor’s. The S&P MidCap 400 index was up 5.6% during that span, while the S&P 500 and the SmallCap 600 indexes were up 1.1% and 3.1%.

Similarly, mid-cap funds topped all other fund categories through the first ten months of the year. Mid-cap blend funds gained 3.9%. Mid-cap growth funds climbed 3.6%, and mid-cap value funds rose 3.1%. By comparison, the average domestic equity fund returned 2%.

Investments in mid-cap funds increased to $36 billion last year, from $25.2 billion in 2003, and $14.9 billion a year earlier, according to Financial Research Corp. The funds had attracted $22.3 billion this year through September 30.

However, a number of market watchers think investors will begin moving into big companies some time next year if interest rates and inflation rise and the U.S. economy slows. In that kind of environment, investors will prefer the stability and maturity that large businesses can offer, they say.

Also, relatively small companies may be hurt by tightened monetary policy because they’re more apt to carry long-term debt, and therefore worse off if they need to borrow, said Kenneth Shea, director of global equity research at Standard & Poor’s.

“I think you’re going to see money rotating towards the S&P 500 and large-caps,” said Shea. “I think interest rates are going to be the biggest catalyst to get them there.”

In the same vein, Sam Stovall, chief investment strategist for Standard & Poor’s, said he does not think mid-caps are poised to outperform other stock categories much longer. “I think they must be in the eighth inning, or so, by now,” he said.

James Lloyd, senior analyst with The Leuthold Group LLC, which provides market research, expressed similar sentiments.

None of the three men had any firm explanation for why mid-caps have stayed ahead of stocks of larger and smaller companies lately.

Shea noted that investors have been embracing small and mid-caps over the last few years, indicating that they have been more willing to accept risk to gain higher returns. The rise of mid-caps may be a sign that people will still go out on a limb, but not as far as before, he said.

In general, stock pickers point out that mid-sized companies can grow as quickly as small ones and faster than big ones. Unlike small companies, mid-sized ones also tend to have established products and proven track records of generating earnings. The last two attributes, Stovall said, can make mid-sized companies “prime” candidates to be acquired by big ones.

Lloyd said mid-cap stocks tend to hold up better than small-caps in down markets. “When the world starts to go in the wrong direction, the small-cap action can turn pretty ugly, and mid-caps are maybe a little safer bet,” he said.

David Kelley, co-manager of the $1.4 billion RS Investment Trust:Value Fund (RSVAX) said one reason why he likes medium-sized companies because their top executives are accessible, which is not always the case with big businesses.

Kelley’s fund, ranked 5 Stars by Standard & Poor’s, was one of best performing mid-cap value funds for the three and five years ended last month. It returned 32.8% and 16.2%, respectively, in those periods, while its peers rose 20.5% and 8.8%, on average.

Kelley said one stock he likes is Regis Corp. (RGS), which operates and franchises hair salons, including the Jean Louis David and Supercuts chains. The company also runs schools that train stylists.

The company features a stable revenue stream and solid and improving returns on invested capital, said Kelley, who also thinks Regis can increase its free cash flow by at least 10% annually for the next three to five years.

Another favorite of Kelley’s is MI Developments Inc. (MIM), a commercial and industrial real estate company. MI generates free cash cash flow and, unlike similar companies, has very little debt on its balance sheet, the fund manager said.

Leslie Globits, co-manager of the $207 million Victory Special Value Fund (SSVSX), said it began buying energy and related stocks in mid-2004. The fund’s holdings in the sector include a pair of coal mining companies, Peabody Energy (BTU) and Arch Coal (ACI), which Globits sees benefitting from increasing demand for coal from utilities.

Victory Special Value, ranked 4 Stars by Standard & Poor’s, generated the second-best returns among mid-cap value funds for the one-year year period ending last month month, gaining 24%, compared to 14% for its peers. has more mutual fund news from Standard & Poor’s available here.


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