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Mid-caps hit sweet spot
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September 29, 2000: 11:37 a.m. ET
Medium-sized stocks are besting their better known large-cap counterparts
By Staff Writer Mark McLaughlin
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NEW YORK (CNNfn) - It took a swoon in the performance of large company stocks, but mid-caps, the middle children of the U.S. equity markets, are finally getting noticed. Mutual funds holding mid-cap stocks are outperforming their larger peers by a wide margin this year and analysts see the rally continuing.
Wedged between the small stocks that trade infrequently and the large stocks that are household names sit the mid-caps. The category didn't even exist 10 years ago -- Standard & Poor's created it with the launch of its MidCap 400 index in 1991 -- and it is still easy to miss. In fact, the value of some of the hottest IPOs zoom right past the market segment within weeks of going public.
But to ignore mid-cap stocks, companies which carry market capitalizations roughly between $1.5 billion and $10 billion, is to ignore a group that delivers a better combination of risk and return than other size U.S. stocks, according to Prudential Securities.
 "It's a category that does not get as much attention," said Steven DeSanctis, director of small cap research at Prudential. "Mid-caps do provide better returns than large caps over time, with only a little more risk."
Managers that run large-cap funds are now dipping down into mid-cap land in search of performance while small-cap managers are moving up to find stability, DeSanctis said.
Both groups are chasing mid-cap growth funds, which are up an average of 15.13 percent this year through Sept. 25. Over the last three years, the average mid-cap growth fund is up 27.4 percent, compared with 23 percent for the average large-cap growth fund.
Fund companies have jumped on the bandwagon and now offer 487 mid-cap funds. That's an increase of 85 percent from the 263 such funds that existed five years ago. While most mid-caps funds are actively managed, investors can also choose from a variety of index funds and the newer exchange traded funds that mimic the growth and value sections of the S&P MidCap 400 or Russell MidCap indices.
Surviving growing pains
So what's the attraction of mid-caps? Think of these companies as teen-agers hitting a growth spurt. They have the energy and potential of a child and the growing maturity of an adult. By the time a company graduates to the mid-cap segment it has survived the hazards of a startup and established a successful path to profitability.
"With small caps you're not sure if they will make it, not sure if they will have the cash to weather hard times," said Chris McHugh, lead manager of the Turner Midcap Growth fund. "The successful small-cap companies become mid-caps."
Mercury Interactive, one of the top holdings of the Turner fund, is one such company. Originally founded as a developer of back-office software for corporations, Mercury moved into software testing to help those same clients prepare for Y2K.
It now works out the bugs on Web sites before they go live and will soon expand into the testing of wireless networks. The company funded such expansion by consistently growing its profit and now possesses the diversity to weather a downturn in any of its markets.
Like teen-agers that grow six inches in a year, up-and-coming mid-cap stock throw off sizzling revenue and earnings growth. The average stock in the Navellier Mid Cap Growth fund, for instance, has grown earnings by 165 percent over the last year and 25 percent during the last three years, said fund manager Louis Navellier.
But it's not just growth that makes these stocks attractive. Even with their run-up over the past year, the valuation of mid-caps still hover near their all-time lows, according to Prudential's DeSanctis. That means investors will pay less for the same earnings growth they could get from more expensive large cap stocks, he said.
And for those seeking diversification from their large-cap holdings, pundits agree that mid-caps will do the trick. DeSanctis said mid-caps provide nearly the same exposure as small caps with lower risk.
"They should be a core holding of everyone's portfolio," said Navellier, who recommends investors hold 40 percent of their assets in mid-caps.
* Disclaimer 
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