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Mid-Cap Funds for Your Large-Cap Portfolio

Make sure your mid-cap fund isn't creeping up the market-cap ladder.

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While mid-blend funds often get overlooked, they're a pretty good idea in principle. Most investors' stock portfolios are anchored in large-caps, so a swath of mid-caps can serve as a nice complement. But while it might seem that the mid-blend category would be a happy hunting ground for a balanced mix of mid-cap growth and value stocks, there are some caveats.

Many of the funds in the mid-blend category are actually more go-anywhere or go-everywhere funds than dedicated mid-cap vehicles. Pairing a nondedicated mid-blend fund with a large-cap fund could very well lead to a bigger chunk of large-caps than you want, so a bit of care is needed when selecting a fund from this group.

One simple, effective approach to the problem is to simply buy an index fund.  Vanguard Mid-Capitalization Index (VIMSX) is a virtual no-brainer, although the shop's decision to switch the bogy from S&P Midcap 400 index to the MSCI U.S. Mid-Cap 450 index does make it a less-perfect match with their  Vanguard 500 (VFINX) index fund. Still, it's very well-run and quite cheap. If you do decide to go with a passively-managed option, watch costs:  ProFunds Mid Cap (MDPIX) has a confiscatory 1.69% expense ratio.

Many investors, however, simply prefer actively managed funds. While the Vanguard fund's solid long-term returns argue otherwise, some believe that the less-efficient mid-cap universe gives a leg up to active managers. So we'll concentrate our efforts on actively managed funds.

One trick for finding a mid-cap fund that diversifies a large-cap-heavy portfolio is to look at a fund's R-squared score against the S&P 500 index. An R-squared score reflects the percentage of a fund’s movements that can be explained by movements in its benchmark index: The higher the number, the greater the correlation between a fund and its index. So you could look for a mid-blend fund with a below-average R-squared score. But such a method doesn't look at the fundamentals: the fund's holdings.

Looking for mid-blend funds invested primarily in mid-cap stocks is a bit tricky. It's actually somewhat easier to instead look for mid-blend funds that invest a relatively low amount of their assets in large-caps. That's what we'll do using Morningstar's  Premium Fund Screener.

First, we'll limit the universe to funds that are members of the mid-blend category whose equity style boxes remain mid-blend. Then we'll limit the search to one share class per fund by selecting "Distinct Portfolio Only," and we'll also eliminate index funds. Now we come to the heart of the screen. We'll say we want a maximum of 25% of assets to be held in large-caps, but there's no way to simply screen for that. Instead, we'll demand that the funds hold no more than 8% of assets each in large-cap value, large-cap blend, and large-cap growth stocks. Finally, we'll screen out closed funds.

To run this screen for yourself, click  here.

As of Oct. 22, 2004, the screen yields 25 funds. We'll highlight three funds that have really impressed our analysts.

Manager Thyra Zerhusen's universe stretches from the $1 billion to $10 billion market-cap range. That bleeds into the large- and small-cap ranges as Morningstar sees it, but it's still definitely a mid-cap fund. It also concentrates on firms with a mix of comparatively strong growth and decent valuations, meaning it's got a lot of mid-blend stocks and relatively even amounts of growth and value stocks. The portfolio is certainly compact--it now holds only 36 stocks--so it's a bit volatile. That said, Zerhusen's record as a stock-picker is very strong, driving nifty returns.

 Vanguard Strategic Equity (VSEQX)
At the other end of the strategic spectrum lies Gus Sauter and Joel Dickson's very broadly diversified quant fund. This cheap offering now holds 353 stocks, with only about 8% of assets in large-cap territory. The fund's benchmark is the MSCI Small- and Mid-Cap 2200 index, so while it holds two-thirds of assets in mid-caps, there's plenty of small-caps. Also, the portfolio has long leaned toward the value side of the style box. The true highlights here are a very disciplined, risk-conscious strategy and Vanguard's trademark low pricetag.

 FAM Value (FAMVX)
Yes, the name suggests that the fund belongs in another category, but it's pretty common for funds that buy value fare and hold for a long time to end up in blend categories. As a matter of fact, this fund looks pretty balanced, style-wise, with 29% of assets in value stocks and 23% in growth stocks--the rest being in the blend area. Managers Thomas Putnam and John Fox tend to skew toward value sectors, though, leading to a big financials stake and very little tech and health. Despite holding only 45 stocks, the fund has very low volatility compared to peers, and quite solid returns to boot.

Todd Trubey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.