SALT LAKE CITY -- They don't have the big-chip cache of the large-cap funds or the diamond-in-the-rough promise of the small caps, but mid-cap mutual funds have consistently outperformed both of those asset classes over the past decade and there's no reason to think that trend will end anytime soon.

During a breakout session titled "Meet Me In The Middle: The Case For Mid Caps" here at the National Association of Personal Financial Advisors' national conference, Derek Smashey, assistant portfolio manager at Scout Mid-Cap Fund, laid out a pretty compelling argument that advisors and their clients should look to the middle for fat returns.

Smashey showed attendees how since January 1979 the Russell Midcap Index has easily outpaced the performance of the S&P 500, the Russell Top 200 (most large-cap stocks) and the Russell 2000 (mostly small-cap stocks).

In fact, a $10,000 investment in fund tracking the Russell Midcap Index would now be worth in excess of $625,000 today compared to roughly $350,000 had you invested in a fund tracking the S&P 500 Index.

"[Midcaps] work because they either are the top-performing asset class in a given period or they're consistently close to the top-performing class," he said. "But also they blow away third place almost every time whether you're talking about one-year, three-year, five-year and, especially 10-year periods."

The reasons for midcap funds' prowess has long been attributed to the fact that they are -- for whatever reason -- comparatively undervalued and underappreciated both as individual stocks and when grouped together in a fund.

Also, the conventional wisdom went, the midsized companies tend to be acquired at a significant premium and with more regularity than their small-cap brethren and they're widely viewed as having as good or better management teams than the big boys.

Smashey and the folks at Scout wanted to look a little closer at the data to see if there was any merit to these prevailing theories.

Turns out there was some validity. Quite a bit, actually.

Using comprehensive mutual fund data from Morningstar, Smashey found that while midcap stocks represent 19.3% of the domestic equity universe, midcap mutual funds only account for 15.1% of mutual fund assets. In other words, they are underrepresented as a group.

As a group, midcap stocks' earnings outperformed the earnings of companies found in the Russell Top 200 and Russell 2000 in seven of the last 10 years, a clear sign that these medium-sized firms were at least holding their own or better against both large- and small-cap companies.

Since December 2009, 163 companies found in the S&P 400 Index -- a baseline for this comparison that includes a lot of midcap companies -- were acquired, or 41% of all the stocks in the index. Meanwhile, only 22 companies (22%) in the S&P 100 -- where the big dogs reside -- were snatched up in this same period.
Meanwhile, 286 deals were consummated from the S&P 600 crowd, which would naturally include a bunch of small-cap companies, or 48%.

This data makes it clear that while more small-cap companies were acquired during this period (48%) the difference was tiny compared to the deals consummated in the midcap space (41%).

"One reason for this is when you're a large cap, those nickel and dime deals don't move the needle," Smashey said. "If you go get a midcap you can probably pick up a couple cents a share in earnings right away."

So will it last?

Analysts today are forecast earnings-per-share growth of 42% and 31%, respectively, for Russell 2000 stocks in each of the next two years. Meanwhile, they're expecting EPS gains of 18% and 19%, respectively, for Russell Midcap stocks.

In other words, the bar may be set too high for the smaller companies and possibly too low for the midcap companies, meaning the expected movement in the groups' individual and collective stocks (up for midcaps, down for small caps) could be pronounced.

Maybe more important, large-cap companies looking to make a splash are long cash right now and eager to pounce.

"It's hard to find organic growth with a sluggish economy in the U.S. and abroad," Smashey said.

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