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There are times when being in the middle is a good thing. The new century thus far has favored midcap growth funds, which returned over 19% through August. Such funds tend to invest in companies that are neither household names nor start-ups but that fall somewhere in between. The midcap sector outperformed any other type of fund holding a mix of domestic stocks, according to Morningstar Inc. in Chicago, which tracks mutual funds.
According to Morningstar, the term “midcap” is a shorthand way of saying “middle-sized capitalization.” The typical midcap company has a market value of around $9 billion, compared with $69 billion for large-cap companies and a little more than $1 billion for small-caps. Midcap funds emphasize midcap growth stocks where sales and earnings are expected to accelerate rapidly-recent holdings include lesser known, established firms such as MedImmune Inc. (Nasdaq: MEDI), Citrix Systems (Nasdaq: CTXS), and Comverse Technology Inc. (Nasdaq: CMVT).
Among all categories of diversified U.S. stock funds, the midcap growth category has been the leader in annualized returns for the past three (32%), five (25%), and 10 (21%) years. In 1999, the category returned a sizzling 65%. “midcap growth funds have the heaviest technology weighting of any diversified stock fund,” says Kelli Stebel, an equity fund analyst at Morningstar. “That has made them volatile, but they have produced excellent returns overall.” Several fund managers boosted returns this year by well-timed moves into hot areas such as biotechnology and energy.
Midcap funds bode well for individual investors looking to add more than growth potential to their portfolios. “They’re a distinct asset class,” says Percy Bolton, a certified financial planner in Pasadena, California. “Including them in a diversified portfolio can increase overall stability because they may hold up when other investments don’t do well.” When smallcap value funds fell in 1998, for example, midcap growth funds came through with a return of nearly 18%.
Bolton suggests that an aggressive investor might hold 15% of a portfolio in midcap growth funds, but the more conservative investor might hold 15% of a portfolio in small cap and midcap funds. “If you want to invest through mutual funds,” says Bolton, “you have to look hard at what’s actually in the fund. The name of the fund may not matter.” Indeed, some midcap growth funds are “barbell” funds, according to Stebel. In other words, they hold a mix of small- and large-cap stocks so that they wind up with an average that’s in midcap territory.
“Many midcap growth funds are high-turnover funds,” says Lewis Walker, a Norcross, Georgia-based financial planner. “If they trade a great deal, [those trades] may realize gains, which must be passed through to investors. Therefore, if you have the option, you should hold these funds in a retirement plan such as an IRA or a 401(k) where taxes can be deferred.”
Walker contends that many investors are underweighted in midcaps because they focus on large companies with familiar names. “Therefore, they miss out on some great growth opportunities,” he says. Bolton’s category favorites are