Earnings growth is slowing down, even among the country’s most consistent earnings growers. Over the last five years, the Russell Midcap Growth Index has seen average annual earnings per share growth of 16.4%. This year Ron Zibelli, who manages the Invesco Oppenheimer Discovery Mid Cap Growth Fund, estimates earnings growth will be in the high single digits for the benchmark index, and in the 12% area for his fund’s portfolio.

The anticipated growth for both measures is quite a bit better than what many observers expect for the large-cap S&P 500. At the start of 2019, analysts saw double-digit earnings growth for that benchmark over the previous year. Now, many expect growth for the index to flatline. At the same time, the performance of small-cap stocks has proved disappointing.

Zibelli says a confluence of factors make mid-cap stocks, which he defines as those with $4.5 billion to $40 billion in market capitalization, an attractive place to be. “Mid-caps appear to be a sweet spot among domestic equities,” he says.

Large companies are being buffeted by a number of headwinds. Over a decade into the current economic expansion, GDP growth has slowed to around 2% in the U.S., and the slowdown is even more pronounced in other parts of the world. That restrains revenue growth, particularly for companies that derive a significant portion of their revenue from foreign sources. A stronger U.S. dollar means that overseas profits translate into fewer U.S. dollars. Rising labor costs, tariffs and what Zibelli calls “the widespread influence of disruptive innovators with new business models and technologies” are challenging the profit models of large incumbents. The tailwind from corporate tax cuts has also died down.

While some midsize U.S. companies are also affected by those factors, they usually don’t feel them as sharply as large multinationals because their customers tend to be closer to home. They are also in a better position to be the disruptors, rather than the victims, of older business models. “It doesn’t make sense to buy a Gillette razor when Harry’s [an online seller of shaving supplies] sells them at a discount,” Zibelli says. “And over the years I have come to appreciate how mid-caps can be more insulated from macroeconomic issues. At the same time, they are at a point in their life cycles where they have perfected their business models, are scaling their businesses and have more professional management. It’s a productive phase of a company’s life cycle that lends itself to superior growth.”

Small Caps Grow Up

Like a proud parent, Ron Zibelli gets satisfaction from watching stocks in his portfolio grow from the challenges of their small-cap childhoods into more mature midsize companies with recognizable names. But there was a time when he could only watch that growth from the sidelines. Before joining OppenheimerFunds in 2006 to head up its small-cap growth strategy, he’d been managing small-cap funds at Merrill Lynch. Over the years, small companies climbed out of reach when they became too big for his firm’s small-cap portfolios. “It was frustrating to have to sell them when they became too big, then watch them move into a huge run as mid-caps,” he says.

Since he began leading OppenheimerFunds’ mid-cap growth strategies in 2010, however, he’s been able to keep many of those once-fledgling companies under his supervision in the Invesco Oppenheimer Discovery Mid Cap Growth Fund. He is also the portfolio manager of the firm’s small-cap offering, which allows him to home in on up-and-comers early on. About half the stocks in the mid-cap fund were once holdings in the small-cap fund, or still are. “We think the ability to develop relationships and information networks with companies early on is our secret weapon,” Zibelli says. Most of the 90 or so portfolio holdings aren’t in the benchmark index, and the ones that are usually appear in different proportions than their index weighting.

The mid-cap assets under his wing ballooned when Invesco acquired OppenheimerFunds in 2019 and Zibelli assumed management, along with Justin Livengood, of Invesco’s mid-cap fund as well. The acquisition followed a number of others for Invesco in both the passive and actively managed corners of the investment world, including its deals for PowerShares, Van Kampen and the ETF business of Guggenheim Partners. Zibelli says his two funds, which have a combined $5.2 billion in assets, invest very similarly. “Our capacity is well north of the current asset under management,” he says.

The higher-than-average growth rates of the companies, along with their above-average price-to-earnings multiples, make the portfolio look somewhat aggressive. But Zibelli tempers that profile by investing in what he calls “premier” growth companies that have superior quality characteristics—such as leading market shares, sustainable competitive advantages, superior management and strong products or services.

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