Second Times A Charm

After making a false start, B.E. says now is a better time to buy mid-cap growth funds

We got it wrong. We thought December 2000 was a good time to jump into mid-cap growth funds. That wasn’t the case, although it looks to be true now.

Our thinking at the time was this: Funds investing in the growth stocks of mid-range companies had done well during 1999 when they returned an average 65% total return. The streak continued during the first eight months of 2000, with mid-cap growth funds posting an average 43.10% gain, compared to 10.64% for the Standard & Poor’s 500 index.

Wall Street calls that kind of thinking momentum investing, just a fancy way of saying that you’re using your money to chase trends that have already taken flight. In this case, however, the economy cooled and profit growth hit the skids. Mid-caps, the stocks of companies with a market value ranging roughly between $1.3 billion and $8.7 billion, lost momentum. When 2000 closed, mid-cap growth funds had lost an average 4.7%, according to Morningstar. That’s a bit better than the -9.1% the Standard & Poor’s 500 index managed, but an ugly showing, nonetheless.

Now, 18 months later, a cool economy has turned cold. Yet, for investors on their toes, it’s a good time to build positions to benefit from a drop in stock prices and an economic rebound down the road. For starters, stocks4and mid-caps in particular4are cheaper than they’ve been in quite some time. The week following the Sept. 11 catastrophes, almost any market index you could point to had dropped 10% or more, including the S&P 500 and Dow Jones industrials.

Yet, mid-cap stocks managed to do worse than that. Data compiled by the Frank Russell Company, a Tacoma, Washington-based firm that tracks stock market statistics, shows the Russell 1000, the firm’s index that tracks large- and midcap stocks, dropped 8.48% during September 2001.

In the later stages of a recession and at the beginning of an economic recovery, mid-caps historically show a lot of get-up-and-go. Consider statistics compiled by New York-based Prudential Securities strategist Steven DeSanctis covering market activity during 10 recessions between the years 1945 and 1991. On average, as the slowdown was ending, mid-cap shares averaged a 21.3% total return, while large caps posted 15.8% over the same period.

“During recoveries [in] the past two decades, the statistics show mid-caps tend to outperform large company stocks during rebounds,” says Dave Hintz, a senior research analyst with Frank Russell.

That left us with the task of finding solid mid-cap growth funds. We tapped Morningstar’s databases and looked for portfolios with the best returns over the past three years. As of the end of January, a few managed to log gains for 2001, but overall, our top five posted very solid total returns of between 14% and 27% over the previous 36 months.

The mid-cap growth portfolio at the top of our list also weathered 2001 with a sizeable gain. Needham Growth (NEEGX), a fund Morningstar gives its top five-star rating, managed a 12.1% return last year, and 27.4% annually over the last three years. Needham growth

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