“During bull markets led by large growth stocks, mid-cap value funds tend to lag. However, if stocks are rising because of accelerating economic growth, the mid-cap value category can prosper. In fact, as investors are becoming a little more optimistic about the U.S. economy in early 2013, mid-cap value stocks are rallying. In January, the Vanguard Mid-Cap Value Index fund (VMVIX on ‘Investor’ shares) gained 7.2%, vs. 5.2% for the S&P 500.
“Fund investors who want exposure to the mid-cap value category and prefer index funds would do well to choose the Vanguard fund. However, our long-time favorite fund in the category is an actively managed one: American Century Mid Cap Value (ACMVX). Over the past five years, the fund has produced an annualized gain of 8.4%, beating the index fund by 2.1 percentage points a year.
“We currently include ACMVX in [five of our recommended] models. The fund’s five-year record is so sterling in no small part thanks to its relatively benign loss in 2008: 24.5%, vs. 37.0% for its average peer (and 38.5% for the Russell Mid Cap Value Index).
“The fund is managed by American Century Investments’ value investing team, led for many years by the relatively unheralded, but nonetheless excellent, Phil Davidson. Davidson and the fund’s three other managers invest according to the belief that companies that are operating better than their historical norms are likely to regress, while high-quality companies that are operating at historically low levels are likely to improve. So, they like to buy underperforming companies when their valuations fail to reflect likely improvement. In fact, to be a purchase candidate for the mid-cap value fund, a stock must be trading cheaply on at least three traditional valuation characteristics. At the same time, they attempt to avoid companies whose valuations reflect expectations of continuing above-average performance.
“To determine whether or not a depressed company can rebound, Davidson et al. analyze the quality of the company’s business. They look for excellent products/services, technologies, brand names or physical resources as well as below-average debt levels. They seek to understand the causes of the current weakness and to feel comfortable that the company has the wherewithal to survive an even more severe downturn in the business. Above all, they want to avoid suffering ‘permanent losses’ in companies that may not recover from difficult times. This focus on quality assets helped the team avoid the worst of the banking and consumer finance industries in 2008.
“To decrease the risk of having too much or too little in a sector, the team keeps the sector weightings of the fund within 10 percentage points of those of the Russell Mid Cap Value Index. As of November 30, 2012, American Century Mid Cap Value was more defensively positioned than the Russell index, with more in healthcare, utilities and consumer staples stocks and less in financial services, consumer discretionary and materials holdings. As a result, the fund was up 5.8% in January 2013 — more than the broad market, but less than the Russell index.
“Though the fund’s portfolio turnover has fallen in recent years to average levels, Davidson et al. tend to engage in active rebalancing by selling appreciated holdings on strength and using the proceeds to buy more shares of holdings that haven’t done as well but continue to have strong potential to rebound. A holding is eliminated outright if two or more of its valuation metrics measure in the top half of the market. Therefore, the fund is an especially appealing choice for tax-deferred accounts.
“The fund recently held 115 stocks. Individual holdings are limited to about 3% of assets (most are much less). Because American Century Mid Cap Value includes some larger-cap stocks, the median market capitalization of the holdings was recently $10.4 billion, vs. $7.1 billion for the benchmark. Many of the holdings pay dividends; the fund’s dividend yield was recently 2.5%, and its expense ratio is a reasonable 1.01%. We recommend the fund highly, because even conservative investors should be able to live with it through entire market cycles.”
- Mark Salzinger, The No-Load Fund Investor, February 2013