by Ari Charney, Featured Expert, Investing Daily
A couple of weeks ago, I examined the consensus holdings among nine top-performing, small-cap mutual funds. My goal was to find those stealth stocks that enjoy the rare concurrence of at least several of the very best small-cap fund managers.
This time around, I was inspired to focus on mid-cap stocks because of an interview I conducted with Madison Mosaic Mid-Cap (GSTGX) fund manger Rich Eisinger late last year. Eisinger said he favors mid-caps because their underlying companies tend to have established competitive advantages, such as a strong brand, but aren’t yet so large that their size inhibits future growth.
In other words, these stocks boast many of the same growth characteristics as small caps, but their businesses have matured to the point where they have at least some economic moat protecting them from encroachment by competitors.
Beyond that, mid-cap stocks have had quite a run over the past decade, beating both small caps and the broad market by meaningful margins. Over the trailing 10-year period, the S&P MidCap 400 gained 9.8 percent annualized versus 8.7 percent for the small-cap Russell 2000 and 6.4 percent for the S&P 500.
So let’s identify the funds whose portfolios we’d like to mine for ideas. With Morningstar’s Premium Fund Screener, I can set seemingly impossible standards for performance and see what results. First, I looked for funds that beat the market over the one-year, three-year, five-year, and 10-year trailing time periods.
Additionally, I wanted funds whose managers are focused on risk reduction, but I didn’t want to rely upon obscure metrics such as standard deviation or beta. Instead, I decided to see which funds managed to lose less than the market during both the bear market year of 2008, as well as in the difficult conditions posed by the market in 2011.
Because Morningstar’s equity style categories aren’t always a full reflection of a fund’s underlying portfolio, I specified that portfolios must have at least a 30 percent allocation to mid-cap growth stocks.
Finally, I didn’t want a new management team getting credit for a prior management team’s performance. As such, at least one member of each fund had to have at least five years at the helm of their current fund. That means they had to navigate one of the most treacherous bear markets in recent history, while still posting outstanding short- and long-term returns.
Here is the list of the nine funds that made the cut:
- Dreyfus/The Boston Co Small/Mid-Cap Growth (SDSCX)
- HighMark Geneva Mid-Cap Growth (PNMAX)
- Madison Mosaic Mid-Cap (GTSGX)
- Meridian Growth (MERDX)
- Neuberger Berman Genesis (NBGNX)
- Nicholas (NICSX)
- Pioneer Oak Ridge Small-Cap Growth (ORIGX)
- Prudential Jennison Mid-Cap Growth (PEEAX)
- T. Rowe Price Diversified Small-Cap Growth (PRDSX)
Though all of these funds produced enviable returns, not all are suitable for the average investor’s portfolio. For instance, some of these funds have sales loads of as much as 5.75 percent, which would be deleterious to long-term returns. Other funds have limited availability due to only being offered in certain plans or brokerages.
Two of these funds are explicitly small-cap funds, but as noted earlier, their portfolios have sizable allocations to mid-cap names. That could mean they have a different definition of the uppermost capitalization threshold for the small-cap universe. Or it could mean that they selected stocks that have since grown into mid-caps and are riding out their gains. Another possibility is that the fund’s success has attracted so many assets, that its large size necessitates moving up the capitalization ladder for at least some of its picks.
Interestingly, five of the nine funds have relatively concentrated portfolios of 60 or fewer names, while six of the funds have annual turnover ratios of 32 percent or less. That means the stocks in a majority of these funds’ portfolios tend to be high-conviction names that management intends to hold for the long term.
With this list of top funds in hand, I then used Morningstar’s Portfolio X-Ray tool to see which stocks were most commonly held among these nine mutual funds. I looked for names that were held by at least four funds. Here’s the list, with the number of funds that hold each stock listed in parentheses:
- Affiliated Managers Group (NYSE: AMG) (4)
- Ametek (NYSE: AME) (4)
- Copart (NSDQ: CPRT) (4)
- Idex Corp (NYSE: IEX) (4)
- IDEXX Laboratories (NSDQ: IDXX) (5)
- LKQ Corp (NSDQ: LKQ) (4)
- MICROS Systems (NSDQ: MCRS) (6)
- Polaris Industries (NYSE: PII) (4)
- Sirona Dental Systems (NSDQ: SIRO) (4)
- Solera (NYSE: SLH) (4)
The next step was to examine each fund’s portfolio to determine whether management increased the size of its holding in the stock during the most recent quarter, or even better, if the stock was a new addition to the portfolio.
Because some stocks were held by more funds than others, I used a point system based on whether the size of a particular holding remained the same from the prior quarter, increased modestly in the most recent quarter, was boosted significantly from the previous quarter or was an entirely new addition to the portfolio. Since the goal is to find those names that might still qualify as current buys in the eyes of management, the latter two criteria received the greatest weightings.
Of these 10 names, LKQ Corp narrowly edged out IDEXX Laboratories. Meridian Growth initiated a new position in the stock during the second quarter (the most recent quarter for which we have such data for this particular fund), while in the third quarter, Pioneer Oak Ridge Small-Cap Growth more than doubled its position to 2.4 percent of assets, making LQK its fifth-largest holding.
LKQ holds the leading share in the highly fragmented market for aftermarket and recycled auto parts. The company has grown via acquisition, and now its relative scale means it’s well positioned to steal market share from its far smaller competitors.
However, the stock trades near its 52-week high, so it’s not exactly in the bargain bin. By contrast, IDEXX, a developer and manufacturer of diagnostic veterinary equipment, is down about 7.2 percent from its 52-week high. Still, both stocks trade roughly 13 percent over Morningstar’s estimate of their intrinsic value. But that’s not uncommon for growth stocks.
Of course, now that we’ve identified some promising candidates, it’s time to undertake additional fundamental research.
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About the Author
Ari Charney is the managing editor of Benjamin Shepherd’s Wall Street and Jim Fink’s Options for Income. He is also an associate editor of Personal Finance.
Prior to joining Investing Daily, Ari took an unlikely path toward dispensing investment advice. Shortly after graduating with a bachelor’s degree in political science from New York University, Ari sampled some of Wall Street’s best-known brokerages and investment banks for several months as a temporary associate. His favorite memory was being paid an absurdly high hourly wage to point and yell at the bond salesmen on the legendary Bear Stearns trading floor when they had incoming phone calls.
Thereafter, Ari spent a substantial portion of his career at financial industry rating services. First, he pored over spreadsheets for the corporate accounting department at Moody’s Investors Service. Later, he analyzed investment newsletters for nearly eight years at The Hulbert Financial Digest (HFD).
While working for the HFD, Ari discovered his passion for helping self-directed investors select the right investment newsletter. Since joining Investing Daily, he’s extended that passion further by guiding investors toward the right securities for their portfolios.
In addition to writing about investment newsletters for the HFD and MarketWatch, Ari has also written about food, music, comics and culture for publications ranging from Mass Appeal to Punk Planet. In his free time, he and his wife tote their son along on their ethnic dining adventures in pursuit of the fabled Bosnian burger and the Thai restaurant with the secret Laotian menu.