(MONEY Magazine) – Worried that large-company stocks look increasingly vulnerable to a setback, but still nervous about the volatility of small shares? Well, here's a compromise that's also a compelling opportunity: midcaps. Mid-size firms offer most of the upside potential of mercurial small-caps with stability closer to that of the behemoths.

To find out more about the advantages of running up the middle, reporter Pat Regnier talked to Brian Berghuis, manager of T. Rowe Price Mid-Cap Growth, who focuses on firms with market values between $750 million and $5 billion. The six-year-old fund was one of the first to dedicate itself to the mid-size companies that traditionally have been overlooked by Wall Street analysts. The fund's five-year annualized return of 23.6% (to March 13) beat more than 90% of its midcap growth peers, reports fund rating firm Morningstar. Berghuis even managed to edge out Standard & Poor's 500 by two percentage points a year over that period--not bad considering that large stocks have generated the biggest gains over the past few years.

Q. What's the case for investing in mid-cap stocks?

A. From 1926 through 1997, midcap stocks earned just slightly less than small-caps--11.6% annually vs. 12%--and more than 1 1/2 percentage points over large-caps. But the volatility of midcaps has been significantly less than their smaller brethren. That's the long-term case. The strong argument for buying midcaps today is that they are a lot cheaper than large-caps, even though I expect midcap earnings will increase 15% next year, vs. 10% for blue chips. That's because, like small-caps, most midcaps have underperformed large-company stocks dramatically over the past three years.

Q. Why do midcaps provide high returns with less risk than small-caps?

A. A lot of small companies have tremendous potential, but their business model sometimes isn't proved. They may have earnings but not on a sustained historical basis. With midcaps, the concept of the company typically is proved, yet there's still a lot of room for growth. Also, many small-cap companies have just one key manager. Mid-size companies are usually run by a team of at least three to five top people, which provides more depth and stability.

Q. What are the pitfalls?

A. For one thing, you have to make sure that the right financial controls are in place. Arguably there were clear signs that Boston Chicken--which I owned when the stock fell 61% in the first half of last year--might have been less stable than I thought it was. The financial structure of the restaurant chain turned out to be inappropriate, which is why things unwound so quickly when business dropped off. We were so confident that average-store sales would continue to grow in the mid- to high single digits that we didn't properly assess the downside if those sales didn't materialize. When you're wrong in your evaluation of a mid-size company's operations, the penalty can be severe.

Q. As the companies you invest in continue to grow, couldn't your portfolio morph into a large-cap fund?

A. There is that danger over time. Because I'm committed to maintaining the integrity of the fund as a midcap portfolio, I look for companies with market caps between $750 million and $2 billion whenever I buy stocks. Although I'd love to hold my winners forever, I can't. But I don't eject a company the moment it crosses the $5 billion threshold, either.

Q. These days, what should an investor look for when choosing a midcap fund?

A. Make sure the fund is truly midcap. Some funds migrate to wherever performance is hot. From 1991 through 1993, when midcaps were doing better than large-caps, we saw a lot of funds moving into the midcap space that today are back to investing in large-caps. Check the prospectus to see if midcap investing is part of the fund's charter, and look at the specific holdings to make sure that the manager is true to that mandate. I would also look for funds with portfolio turnover rates no higher than 100%. Transaction costs in the midcap area are steep, so a manager has to add a tremendous amount of value with each trade when the turnover rate is higher than that. I don't think a lot of people can.

Q. So do you think midcaps might be overtaking big-cap stocks anytime soon?

A. Market cycles can last a pretty long time, upwards of seven years, so it's hard to say. But I suspect that when the tide turns toward midcaps, it will be gradual. It might be several quarters before people look up and say, hey, these stocks are really outperforming.