Mid-Cap ETFs Gain Favor

NEW YORK ( TheStreet) -- With major stock market indices pushing higher, the luster of large-cap equities may be wearing off for some.

While these market giants proved to be a welcomed safe haven as global macroeconomic headwinds have plagued investor sentiment during the waning months of 2011, those who have opted to stick to this "big and boring" investing strategy in 2012 have sacrificed some potential gains.

On a year-to-date basis, the iShares Russell 2000 Index Fund ( IWM) has managed to handedly beat out the SPDR Dow Jones Industrial Average Index Fund ( DIA), returning over 12.5% year to date compared to less than 9% for DIA .

As a result, investors may be tempted to shed their exposure to blue chips and wield their microscopes in search of small, fast-moving companies. However, this strategy is not ideal given the current market environment.

Thanks to their upside potential and inherent volatility, firms in the bottom of the size spectrum are typically turned to during periods of market euphoria. The pendulum swings both ways though: Just as they can surge to leadership roles as markets march higher, they can suffer equally swift declines in the event that sentiment turns south.

Evidence of this bipolarity can be seen when looking at IWM's performance since the start of the month. Although the market rally has continued over the past few weeks, the ride higher has not been smooth.

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On the contrary, just last week we were given a harsh reminder of the challenges facing nations like Greece and China. In response to this news, ETFs linked to the Russell 2000 and other major U.S. stock indices took hits. IWM was the clear loser during this downturn, retreating to levels last seen in late-January. The small-cap focused fund has since recovered along with the rest of the market, though it is only now returning to pre-downturn territory.

Although headwinds have subsided, in the event that turbulence returns, investors can expect a repeat of the past weeks' action from IWM. Smaller may appear better, but in order to avoid being taken for a ride, risk hungry investors should consider setting their sights on slightly larger targets.

During the early-year run up, mid-cap stocks have actually led the pack. Investors who bought up shares of the iShares S&P Mid-Cap 400 Index Fund ( IJH) have enjoyed nearly 15% gains.

In addition to this upside action, the fund also managed to hold up better in the face of last week's shakeup. Although it suffered a downturn as EU debt fears and China growth concerns dominated headlines, IJH was quick to rebound. It has since pushed higher, locking in new 2012 highs.

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Small-cap stocks may seem like an obvious choice during periods of strong market action. However, as we have seen throughout the opening quarter of the year, they are not always the best. In this current market environment, mid-caps provide the best mixture of upside potential and safety. Investors considering a foray into risk should have a fund like IJH on the radar when planning their approach.

-- Written by Don Dion in Williamstown, Mass.
At the time of publication, Dion Money Management owned the iShares Russell 2000 Index Fund and SPDR Dow Jones Industrial Average Index Fund.