COLUMN-Smart shopping for mid-caps

CHICAGO, April 7 Mon Apr 7, 2014 3:48pm EDT

CHICAGO, April 7 (Reuters) - Go for the most famous companies when you are investing, and you are likely to pay the highest price possible because most investors place a premium on the biggest-name stocks. But take a look at the roughly 1,500 companies that make up the mid-cap market, and you could be making a pretty solid investment this year.

Mid-caps, with market values between $1 billion and $15 billion, are often the least visible choices in investing. They are big enough to have mature management teams, yet may not carry the same downside risk as a mega-cap or a small company. They may be able to grow more robustly than mega-caps because of their size. And as market valuations have climbed for both mega- and small caps, mid-caps offer returns that are right down the middle of the plate.

The S&P MidCap 400 index returned 23.2 percent for the 12 months through April 4 compared to 22 percent for the S&P 500 index of big stocks and 29 percent for the small-company S&P 600 index.

To gain a broad sampling of mid-caps, you'd need an index fund like the iShares S&P Mid-Cap 400 Growth ETF. The fund invests in a wide basket of mid-cap companies like Keurig Green Mountain Inc, Affiliated Managers Group Inc and Trimble Navigation Ltd.

The iShares fund gained 32 percent last year, roughly tracking the S&P 500. It's up 0.78 percent year to date through April 4. The fund charges 0.25 percent for annual expenses.

A worthy alternative to the iShares fund is the SPDR S&P Mid-cap 400 ETF, which is up 2 percent year to date through April 4. It edged the S&P 500 last year by just under 1 percentage point and also charges 0.25 percent annually for management expenses.

For a more focused and active mid-cap strategy, consider the Baron Partners Retail Fund, which owns companies like Arch Capital Group Ltd, ITC Holdings Corp and Hyatt Hotels Corp. Its strategy is to hold stocks long term with a goal of finding companies whose market value could increase 100 percent within four subsequent years.

The Baron fund, coming off a stellar 2013, in which it gained nearly 48 percent - beating the S&P 500 by 15 percentage points - is up almost 4 percent year to date through April 4. It costs 1.38 percent annually to own. According to S&P Capital IQ's MarketScope Advisor, "The fund is relatively concentrated, with just 26 holdings and more than two-thirds of assets invested in its top-10 holdings." While it's much more expensive than an index fund, its performance may be justified on the return side.

If you're looking for bargain-priced mid-caps, turn to the Vanguard Mid-Cap Value ETF. The fund holds undervalued stocks like Macy's Inc, Delphi Automotive PLC and Western Digital Corp. It charges 0.10 percent annually and is up nearly 4 percent year to date through April 4. It gained nearly 38 percent last year, besting the S&P 500 by more than 5 percentage points.

CRYSTAL BALL

How will mid-caps do this year? There are no guarantees their bull run will continue, but should the U.S. economy continue on its upward trajectory, mid-cap performance may hold up. The companies tend to be slightly more resilient to economic softness and will benefit from improvements in hiring, economic output, retail sales and the housing market.

So far, the signals are all green for mid-caps. Growth in U.S. gross domestic product was revised up to 2.6 percent for the fourth quarter of last year by the U.S. Bureau of Economic Analysis. That compares to 1.4 percent for the same quarter a year earlier.

Last week, Federal Reserve Chair Janet Yellen affirmed the central bank's "extraordinary commitment" to boosting the economy. The Fed has kept interest rates near zero since late 2008 and is expected to continue that policy through this year. The jobless rate is down to 6.7 percent from a post-meltdown high of 10 percent. Inflation is hovering around 2 percent.

What's more important than short-term economic news is taking the long view on mid-caps. They do well over the long run when there's sustained economic growth, showing a pronounced advantage over the more popular mega-caps - even during downturns.

For the past 10 years, for example, a broad-basket mid-cap fund like the iShares S&P Mid-Cap 400 posted a nearly 10 percent annualized average rate of return. That compares to 7 percent for the S&P 500. Keep in mind that period includes the meltdown year of 2008.

But the mid-cap advantage fell behind the S&P 500 over the past three years by 2 percentage points, so to achieve the outperformance over big stocks you need to buy and hold mid-sized companies for the long term. The mid-cap return premium - at least in recent years - occurs when large company prices are at their most volatile. (Follow us @ReutersMoney or here Editing by Beth Pinsker and Leslie Adler)

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