At graduation parties this spring, what is whispered in the graduate's ear just may be “mid caps.” Analysts see these not-too-big, not-too-small stocks as merger targets, ripe to attract plentiful M&A money that's been sitting on the sidelines. Others see the mid-tier companies as poised for growth. One expert is calling them, “Wall Street's best-kept secret.”
Investors tend to place more emphasis on their large-cap and small-cap equity allocations, overlooking the importance of mid-cap stocks in a diversified portfolio, writes Kevin Kloski, a portfolio specialist with New York-based ING U.S. Investment Management who wrote the report “Mid Cap Stocks – Wall Street's Best Kept Secret.” He used Russell Midcap Index's definition of mid-cap stocks: those with a market cap between $126 million and $22.9 million, as of last March.
ING has a MidCap Opportunities Fund - Class A (NMCAX), which has an average annual three-year return of 15.98 percent, as of January 31, after deducting a 5.75 percent front load fee. The fund has no redemption fees and its expense ratio is 1.35 percent, under its peer average of 1.37 percent.
“In general, small caps have higher expense ratios than mid caps, and mid caps have higher expense ratios than large-cap funds,” says Laura Lallos, a Chicago-based senior mutual fund analyst with Morningstar.
Kloski likes the stability of mid-cap companies, their financial strength, and tendency toward a more entrepreneurial and agile structure. Over the past 10-, 20- and 30-year periods, he writes, “mid caps have consistently outperformed both large- and small-cap stocks, while generating stronger risk-adjusted returns.”
William Theriault, a senior vice president in ING’s equity group, says financial advisors who manage asset allocations for their clients may overlook mid caps. “It's basically a time and resource issue. They only have so much time to devote to various asset classes and usually spend an inordinate amount of it analyzing larger stocks.” The larger companies, he says, did well with their ventures into global emerging markets, a strategy he sees petering out now. The momentum, he believes, is toward moving into mid- and small-cap stocks.
Also, with $2 trillion in cash on corporate balance sheets, growing mid-cap companies are expected to induce takeover dreams among companies like Apple and Microsoft. Mutual fund investors holding the target asset class should profit, says Theriault. “Hopefully, you hold the target company,” which may enjoy price appreciation from the deal. “You sell the stock and look for another opportunity in the mid-cap range.”
ING leans toward growth-style mid caps, rather than value, because of what Theriault calls the largest growth-to-value gap in 20 years, widened by investors favoring dividend-paying companies, which tend to be value stocks that he suspects can't sustain their growth.
Analysts at S&P Capital IQ, in New York, also see mid-cap stocks reviving. With the U.S. economy on the mend, they favor growth stocks because they tend to outpace value stocks in the early stages of an economic recovery. The S&P MidCap 400 Index recently hit all-time highs, while the S&P 500, a large-cap index, remained below its all-time high, according to a January 29 report by S&P’s chief technical analyst Mark Arbeter.
Prompted by these and other indicators, S&P screened its mutual fund universe for domestic equity mid-cap growth funds and turned up three promising possibilities. The first two are weighted in the consumer discretionary, tech and financial sectors.