The Best of the Midcap Funds
Midsize companies are safer than small fry but can still grow quickly.
Midsize companies don’t get the attention that big names such as Apple and Google do. But lately, stocks in the middle group have been outshining the big guys. Over the past year, the Russell Midcap index, a measure of in-between firms, returned 28.2%. Standard & Poor’s 500-stock index, which tracks mostly large-company stocks, came in at 21.3%.
The middies benefit from their position in the corporate life cycle: They are more stable than start-ups, but they still have room to grow at above-average rates. That place in the pecking order can be advantageous in an unsteady economy, such as today’s. It can also pay off over the long run. Over the past 20 years, the Russell Midcap index returned an annualized 11.0%. That beat the S&P 500 and the Russell 2000, an index of small-company stocks, by an average of 2.2 and 2.07 percentage points per year, respectively. Moreover, mid-cap stocks beat their smaller cousins with lower volatilityand outpaced stocks of larger companies with only slightly more swings, according to Goldman Sachs Asset Management (all returns are through August 23).
With that kind of record, midsize stocks certainly deserve a place in your portfolio. To that end, here are seven funds, including four members of the Kiplinger 25, whose managers we think are particularly adept at finding the best opportunities among midsize companies. The funds are listed in alphabetical order.
Akre Focus (symbol AKREX)
Although Focus can technically own companies of any size, the majority of the fund’s portfolio holdings land in the middle. Manager Chuck Akre, who previously managed a similar fund at another outfit for nearly 13 years, says midsize firms often have the three things that he looks for in stocks: big returns on business assets, proven executives and a record of smart reinvestment.
At times, Focus, a member of the Kiplinger 25, will look very different from its peers. Financials now make up 33% of the portfolio — almost three times the percentage in the average midsize fund. In the short term, says Akre, “returns can bounce around.” Since the fund’s launch in August 2009, it has returned 17.7% annualized, an average of 0.8 point per year less than the Russell Midcap index. (Over the same period, the S&P 500 gained 15.5% annualized.)
Aston/Fairpointe Mid Cap (CHTTX)
Manager Thyra Zerhusen looks for companies that dominate their industries and can increase earnings consistently. But she also won’t invest in a stock if she deems it overvalued. At last report, the average price-earnings ratio of both the fund’s holdings (based on estimated profits) and the Russell Midcap index was about 17. Low prices, says Zerhusen, help minimize potential losses and maximize gains.
With the help of that discipline, Zerhusen’s fund regularly beats most of its peers in annual performance. One exception was 2011, when the fund came in near the bottom fourth of its group. “We should have rebalanced more forcefully after the market’s rebound,” Zerhusen says. But Mid Cap never stays down for long. So far in 2013, the fund is up 28.8%, once again walloping the majority of its competitors.
Fidelity Low-Priced Stock (FLPSX)
Low-Priced Stock, another member of the Kip 25, is unusual in a couple of ways. For starters, most of the new stocks it buys trade for $35 or less. Also surprising is the fund’s foreign bent: Nearly one-third of the portfolio is invested abroad. Lead manager Joel Tillinghast says that despite big structural problems in their economies, he’s finding ample opportunities in Japan and Europe, where medium-size businesses can trade at half the P/E of U.S. firms. To mitigate risk, Tillinghast sticks to companies that he believes can survive major setbacks. He points to one holding, the Jumbo Group, a retailer in Greece, as an example. Though the Greek retailing sector is in decline, Jumbo has managed to keep sales even.
Low-Priced Stock won’t top performance charts every year, but that’s not the goal. Tillinghast — who launched the fund in 1989 and was joined in 2011 by six co-managers who are each responsible for a sliver of its assets — prefers reliable growers that will survive both good and bad markets. The fund charges below-average annual fees of 0.88%. It all works: Over the past 15 years, Low-Priced Stock returned 11.9% annualized, crushing the typical fund in its category by an average of 3.3 percentage points per year. Our biggest concern about the fund is its size: It holds $42.9 billion in assets.
FPA Perennial (FPPFX)
For this article, we screened out funds with upfront sales fees. Earlier this year, FPA Perennial stopped charging loads for new or existing accounts. With that expense gone, the fund is a more appealing choice for investors.
Perennial is led by Eric Ende and Steven Geist, who have been at the helm for 14 years, as well as Gregory Herr, who joined in early August. The managers search for companies with high profitability and low debt — measures of quality that “lead to predictable earnings,” Ende says. The fund has only about 30 stocks, and the managers don’t mind if the portfolio becomes concentrated in a handful of industries. That can lead to bouts of volatility and performance that’s out of sync with the rest of the market. For example, in 2006 and 2007, when stocks of lower-quality financial companies and others were soaring, Perennial lagged because it didn’t have a big stake in those kinds of firms. Although that dinged the fund’s long-term return, it has performed well since: The fund has been in the top half of its category (funds that invest in fast-growing midsize companies) every year except 2010.
T. Rowe Price Diversified Mid-Cap Growth (PRDMX)
Donald Peters has managed Diversified since its inception almost ten years ago, and Donald Easley became co-manager in 2009. The pair cut risk by holding a lot of stocks; at last count, the portfolio had more than 280 names. Peters and Easley will settle for average earnings-growth rates if a company pays a dividend or buys back shares, both of which offer stability. With this approach, Diversified has built a record of consistent performance. It regularly lands near the middle of the pack, without many big surprises on either the upside or the downside. With an expense ratio of 0.97%, the fund has below-average annual fees.
Vanguard Selected Value (VASVX)
Vanguard hires two separate money-management firms to run Selected Value. James Barrow and Mark Giambrone, of Barrow, Hanley, Mewhinney & Strauss, control about three-fourths of the fund’s assets; Donald Smith and Richard Greenberg, of Donald Smith & Co., handle the rest. The two teams run their portfolios independently, but both place a priority on finding stocks that sell at a discount to their assessment of the underlying company’s true worth. Giambrone and Barrow go after growing companies that have a safety net, preferring stocks that pay a dividend and sport P/Es below that of the market. Smith and Greenberg take a bit more risk. They look for stocks that are dirt-cheap in relation to the underlying companies’ assets.
The marriage seems to work. Over the past ten years, Selected Value returned an annualized 11.2%, compared with 10.6% a year for the Russell Midcap index. Low fees also help. The fund, a member of the Kip 25, charges 0.38% annually — less than one-third the fees of the average midsize stock fund.
Wells Fargo Advantage Discovery (STDIX)
Thomas Pence has been the lead manager of Discovery for more than a decade, but the fund also benefits from the research of more than 20 analysts, traders and portfolio managers. The team tries to balance opportunity with stability. As a result, 40% to 50% of Discovery’s holdings are companies that tend to have stable earnings. Another 40% to 50% are what co-manager Michael Smith describes as “tomorrow’s growth stocks,” companies that aren’t as well established but have potential to earn big returns. And 5% to 10% of assets are reserved for stocks that have stumbled and that the managers expect to recover.
The approach has helped the fund, a member of the Kip 25, excel in all types of environments. In 2011, when jitters about Europe and U.S. debt levels pushed the broad market into the red, Discovery eked out a gain of 0.6%. And so far this year, the fund’s 26.9% return is ahead of the Russell Midcap index by 5.5 percentage points.