Investing In The Overlooked SMid-Cap Space

By Aaron Levitt | July 19, 2011 AAA

For portfolios, the key is to find that perfect blend between risk and reward. With that in mind, many investors join together a variety of asset classes, market capitalizations and world regions to uncover that combination. Typically, a mix of large and small caps is used. One interesting alternative to that combination could exist somewhere in between. SMid-cap portfolios, which blend small- and mid-cap stocks, can be a "Goldilocks" investment with a just-right mixture of benefits for portfolios. The ignored space joins many of the attractive performance attributes of the small-cap sector with some of the stability characteristics associated with larger firms.

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What is a SMid-Cap?
While difficult to define, SMid-cap stocks could be one of the best ways to play the upcoming year in the markets. These stocks typically enjoy stronger cash flows, stable business models and less volatility than smaller equities, but provide more "oomph". Analysts and index providers use two different descriptions to define the asset class. Smaller mid caps, which are defined as those that fall below a certain market-cap breakpoint, and "small plus smaller mid caps", which include both companies considered small-cap and the smaller mid-cap companies. The Russell 2500 Index, the commonly used SMid-cap benchmark, uses this definition to define its universe. Since inception, the Russell 2500 has returned an annual 13.1% while the Russell 200 has returned only 11.8%.

Finally, SMid-cap investing allows investors to stick with a smaller company as it evolves from a startup to a larger firm. Investors can potentially see a larger return over time. For example, robotic surgery company Intuitive Surgical (Nasdaq:ISRG) was a very rewarding small-cap. However, due to market cap constrictions, small-cap indexes were forced to sell the company. SMid-cap investors would have seen a return nearly four times greater.

Playing the Small-Mid Sweet Spot
Surprisingly, given the proliferation of exchange-traded funds (ETFs), there is no ETF that tracks the Russell 2500. For those who want a simple all-in-one allocation to SMid-caps, the Vanguard Extended Market Index ETF (NYSE:VXF) tracks virtually all regularly traded U.S. stocks except those in the S&P 500 Index. However, the fund still includes many large-cap names such as Mosaic (NYSE:MOS). Mutual funds such as Royce SMid-Cap Value do exist, and plenty of great individual names walk the small- to mid-cap tightrope. Here are a few picks.

With continued currency debasement and inflation worries persisting, gold prices have surged over the last few years. Gold miners offer a leverage play on the price of gold. Junior miner Allied Nevada (NYSE:ANV) owns the Hycroft Mine near Winnemucca, Nevada and has seen its share price steadily climb along with the market's fascination with the metal. Allied Nevada has a market cap of about $3.6 billion. (Find out how the PPI can be used to gauge the overall health of the economy. Check out Predict Inflation With The Producer Price Index.)

Overhead Transmission Lines Will Be Needed
Building out the smart grid and adding new sources of renewable energy will take plenty of overhead transmission lines. Among its HVAC systems and various hardware components, Thomas & Betts (NYSE:TNB) is a major manufacturer of steel utility structures including lattice towers and substation units. The company will also benefit from the growth in the wind industry as it produces wind towers as well. TNB has a market cap of $2.7 billion.

Utilities represent one of the few real values left in the stock market. SMid-cap multi-utility UGI (NYSE:UGI) currently yields 3.2%, but it has managed to grow its dividend by 5.9% annually over the last 10 years. The company also benefits from a global focus with operations in France, Austria, Poland and Switzerland. In addition, UGI owns a 44% stake in propane play AmeriGas (NYSE:APU). UGI's market cap is $3.5 billion.

The Bottom Line
Blending the best attributes of both small- and mid-cap stocks, the often-ignored SMid-cap space could be an investing sweet spot. For investors, adding a dose of these stocks could help boost returns while lowering volatility. The previously mentioned picks are examples of firms that fit the SMid-cap mold.

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