A Top T. Rowe Price Fund for Mid-Cap Stocks

Any decent stock fund portfolio should include stocks of all sizes. I've been emphasizing stocks of large companies for years now because of the rocky economic backdrop. But you should also own stocks of small and midsize companies, as well as foreign stocks. No one can predict precisely when one variety will excel or when another will lag.

The Best of the Midcap Funds

T. Rowe Price picks medium-capitalization stocks as well as anyone. The Baltimore-based firm boasts two superior mid-cap funds, T. Rowe Price Mid-Cap Growth (symbol RPMGX) and T. Rowe Price Mid-Cap Value (TRMCX) . If you can buy either one, do so. Both are closed to new investors.

If you can't invest in those, it's time for option three: T. Rowe Price Diversified Mid-Cap Growth (PRDMX). I don't think the fund is quite as strong as the other two, but returns have been good, and the fund's co-managers, Donald Peters and Donald Easley, are impressive. Over the past five years through November 4, the fund has returned an annualized 19.0%, putting it in the top 24% among mid-cap growth funds.

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Diversified's five-year returns fall in the middle of the three T. Rowe Price mid-cap funds. Mid-Cap Growth returned 20.6% annually; Mid-Cap Value, 18.0%. But Diversified is significantly more volatile than the other two.

Diversified has other attributes. Assets are a mere $274 million. That's tiny for a company with T. Rowe Price's resources. A small asset base means the fund can be more maneuverable — a big advantage, especially with small and midsize stocks. The other T. Rowe Price mid-cap funds put up their best relative returns when they were smaller. Finally, the same analysts who do such a terrific job on T. Rowe Price's other mid-cap funds work on this one, too. The co-managers say they rely heavily on these internal analysts.

The most visible negative to the fund, in my opinion: It owns too many stocks. Diversified holds 280 stocks, and no stock makes up more than 1% of the fund. The managers also stick roughly to the sector weightings of the Russell Mid Cap Growth index. The median market cap (share price multiplied by total shares) of stocks in the index is $5.9 billion. Mid-cap stocks are generally defined as having market caps between $1 billion and $10 billion, though many stocks in the index exceed $10 billion.

Diversification is a risk reducer. Mid-Cap Growth and Mid-Cap Value own 134 and 112 stocks, respectively. But assets, respectively, are $22 billion and $10.8 billion. Yes, Diversified has "Diversifed" right in its name. But, in my view, 280 stocks is too much of a good thing.

Still, the fund has plenty going for it. As is usually the case with T. Rowe Pricce, the managers are veterans. Peters has been with the fund since its inception in December 2003. Easley began working on the fund in 2005 and was promoted to co-manager in 2009.

The managers look for high-quality companies with strong, consistent business models, relatively high profitability, and good executives with proven records of spending company funds wisely. The managers typically hold stocks for three to five years.

The fund owns some biotech and some software, but much of the portfolio consists of what Peters calls "steady grinders." These are unexciting companies that can produce solid returns for shareholders.

For instance, the co-managers are invested in two of the big auto-parts retailers, AutoZone (AZO) and O'Reilly Automotive (ORLY). Their reasoning: People own their cars longer than they used to, which leads to more repairs. And few other businesses can do auto supply. (Amazon.com would be a formidable competitor, but Amazon isn't attracted to the auto-parts business because a large inventory needs to be held for a relatively long time to meet the needs of auto-parts buyers.) Finally, both companies are buying back stock.

Ross Stores (ROST), the discount apparel chain, is another favorite. The chain buys "last year's fashions," Peters says. Costs are low, he says, and profit margins are high.

Crown Castle International (CCI) and SBA Communications (SBAC) are two of the leading players in a terrific business: building, owning and leasing cell towers. Cell traffic keeps increasing, the firms' contracts call for periodic price increases, and it's really hard to put up a new tower in most heavily populated areas.

Steven T. Goldberg is an investment adviser in the Washington, D.C., area.

Steve has been writing for Kiplinger's for more than 25 years. As an associate editor and then senior associate editor, he covered mutual funds for Kiplinger's Personal Finance magazine from 1994-2006. He also authored a book, But Which Mutual Funds? In 2006 he joined with Jerry Tweddell, one of his best sources on investing, to form Tweddell Goldberg Investment Management to manage money for individual investors. Steve continues to write a regular column for Kiplinger.com and enjoys hearing investing questions from readers. You can contact Steve at 301.650.6567 or sgoldberg@kiplinger.com.