For Long-Term Wins, Look to Nimble Midcaps

NEW YORK (TheStreet) -- Midcap funds have been leading the parade lately. During the past five years, midcap blend funds returned 0.3% annually, while small-blend lost 0.5% and large-blend dropped 0.7%, according to Morningstar.

Was it a fluke? No, argues Kevin Toney, a portfolio manager of American Century Mid Cap Value Fund(ACMVX). "Midcaps are the sweet spot of the market," he says.

In the 1970s, researchers concluded that small stocks had delivered the best returns. But in recent decades, midcaps have taken the leadership, according to Zephyr StyleAdvisor, an investment data firm. During the 20 years ending in June, the Russell Midcap Index returned 10.2% annually, compared with 8.2% for the Russell 2000 small-cap benchmark and 7.7% for the large-cap S&P 500.

Toney concedes there will likely be periods in the future when small or large stocks lead the markets. But midcaps are the most appealing long-term investments, he argues.

Midcaps tend to outpace large caps because medium-sized companies provide higher revenue and earnings growth, Toney says. Midcap companies are more nimble, swiftly hiring additional workers and increasing production. That has enabled them to outperform large caps during periods when the economy was growing and markets were climbing. During downturns, large stocks have proven more stable and slightly outshone midcaps. But over full market cycles, midcaps typically have won.

Small stocks may outpace midcaps in bull markets. But midcaps prove more resilient in downturns. "Midcaps have more stable balance sheets and better access to capital," Toney says.

Though they make up a third of domestic equities, midcaps account for only 15% of the assets in equity mutual funds, according to Morningstar. "Investors overlook midcap funds," says Peter Zuger, portfolio manager of Touchstone Mid Cap Value Fund. "People buy large caps and small caps, and they figure that they have covered all the bases."