Mid-Cap Value Funds Still Get Boost From Buyouts

Updated from 11:35 a.m. EDT

Did anybody tell mid-cap value funds the private-equity party is over?

The average mid-cap value fund's performance has certainly been nothing to write home about this year, down slightly more than 9%. Yet the asset class, surprisingly, ranks fifth in terms of performance out of the 18 equity-fund categories tracked by Morningstar. The four fund groups topping the table are bear-market, natural resources, long-short and real estate.

Considering that stocks in the $1 billion to $10 billion market-cap range are no longer being snapped up or bid up by flush private-equity shops, the outperformance seems curious.

"It's a matter of degree," says Tom Kolefas, portfolio manager of the $800 million, five-star TIAA-CREF Mid-Cap Value fund TCMVX. "There is still a bid from private equity out there. It's just not as strong and leveraged anymore."

These Mid-Caps Don't Need Private Equity to Thrive

Strategic buyers are still out there as well, according to Kolefas. He points out that corporate balance sheets remain stuffed with cash. American companies are also less leveraged, meaning they can still borrow to meet growth targets, surely an attraction for investors in a slowing economy. Kolefas' fund is down 8.6% year to date, and has returned an average of 20.3% annually over the past five years.

"Our fund tries to find underleveraged companies with good balance sheets and high free cash flow generation," says Kolefas. "When the economy is doing well, nobody values the virtues of clean balance sheets. But when the crunch hits, all of a sudden people remember how important it is."

One of his top picks is food-and-beverage packaging provider Crown HoldingsCCK, due to its high free-cash flow, and the fact that it likes to pay down debt. Despite inflation hitting Crown's -- and everybody else's -- raw-material costs, Kolefas maintains, "there are a lot of ways to win with this company."

"Industry consolidation, rising earnings and innovation into new products, it's all good," says Kolefas. "People have to eat and drink no matter what, so demand is stable and even rising in the emerging markets. Raw-material price increases are being offset by rising prices."

Darden RestaurantsDRI is also a victim of rising input prices, but Kolefas says its value proposition has attracted enough cost-conscious consumers to more than make up for the inflation pinch.

Kolefas also believes there is hidden value in Darden's real estate holdings. The company owns more than 60% of the real estate underneath its stores, and could theoretically sell it and lease it back, thereby getting it off its balance sheet.

"Even though it's in a consumer sensitive sector, we like Darden because their restaurants have outperformed industry comps," says Kolefas. "Same-store sales have been positive when everybody has else gone negative. Olive Garden and Red Lobster have been the perfect places where people get more for their money."

More pasta for your moolah?

Hard to beat that value proposition.

Know What You Own: Crown Holdings operates in the consumer goods industry, and some of the other stocks in its field include Ball BLL and Silgan SLGN. These stocks were recently trading at ($42.60, -1.50%) and ($45.90, -1.29%) respectively. For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.