She sticks to the playbook when buying and selling midsize stocks. By Anjelica Tan, Reporter September 27, 2012 More so than most fund managers, Diane Jaffee plays by the rules. To be more specific, she relies on an unusually tight set of conventions to run TCW Value Opportunities (symbol TGVOX), a fund that invests mostly in stocks of midsize companies. "We have a rule for almost any possibility," says Jaffee, a 30-year investing veteran who took the fund's reigns in June 2011.SEE ALSO: Kiplinger's Guide to Mutual Funds Playing by the rules has paid off for Jaffee. Over the past year through September 26, the fund returned 30.7%, beating its benchmark, the Russell Midcap index, by 8.4 percentage points and Standard & Poor's 500-stock index by 4.6 percentage points. Over that period, TCW ranks in the top 4% of its peer group -- funds that invest in midsize companies with a blend of growth and value attributes. One of the rules that's led to success: diversification. Jaffee makes sure her fund always has some money in each of ten major economic sectors. But compared with allocations in the Russell Midcap index, her fund never has more than twice a sector's weighting in the index nor less than half. At last word, the fund was most heavily weighted in consumer cyclicals and financial services, both of which have outperformed the broad U.S. market over the past year. Advertisement When deciding which stocks to buy, Jaffee has more leeway. For each one she considers, she determines which of five ratios -- price-to-earnings, price-to-sales, price-to-cash flow, price-to-book value and dividend yield -- has been most relevant over time. If she spots a company with a cheap share price and a catalyst that could lead to improving results -- for instance, development of new products or the arrival of a new CEO -- she buys. To some degree, Jaffee also relies on a rule to determine when to sell a stock. Like most value managers, she'll sell when a stock becomes overpriced -- in her case, when it becomes overvalued relative to the primary ratio she uses for that company. But she also looks to the market itself to tell her when something may be amiss. If, over a 30-day period, a stock she holds lags its benchmark by ten to 15 percentage points, she automatically reevaluates it. She'll see how the stock measures relative to the other valuation ratios she examines. The deciding factor is whether Jaffee believes the stock can post a 30% return over the next one to two years. If not, she sells part or all of her stake in the company. Jaffee considers the midsize category to be the stock market's "sweet spot." Midsize companies, she says, are still small enough to grow quickly, but they have enough size and "seniority" to make them less risky than small-company stocks. At last report, Value Opportunities' biggest holdings were disk-drive maker Western Digital (WDC), homebuilder Toll Brothers (TOL), retailer American Eagle Outfitters (AEO), specialty chemical maker Cytec Industries (CYT) and conglomerate Textron (TXT). Follow Anjelica on Twitter Kiplinger's Investing for Income will help you maximize your cash yield under any economic conditions. Subscribe now!