Smaller Than Blue Chips, Safer Than New Chips

Small-cap stocks have gotten great fanfare lately, and with good reason. As measured by the NASDAQ composite index, they are already up 44% this year, compared with a 15% rise in the Dow Jones industrial average. But halfway between blue chips and new chips lies a stock group whose day in the sun may just be dawning. Since June, when Standard & Poor's introduced the S&P MidCap 400 index, investors have a performance benchmark for a stock universe that could combine the best of both worlds. (S&P is a subsidiary of McGraw-Hill, which owns BUSINESS WEEK.)

The stocks that make up the index, with a median market capitalization of about $700 million, together have greater growth potential than bigger ones but less volatility than smaller ones. At a time when the economy is struggling, small stocks usually outperform blue chips, because niche companies tend to be more independent of overall economic trends. Meanwhile, the inclusion of some large companies in the index should offset the smaller ones' riskiness.

So far, only one mutual fund has sprung up to mirror the S&P 400 performance: Dreyfus People's MidCap Index Fund (800 782-6620). The no-load fund started in August with $5 million in assets. Minimum investment is $2,500, and total return through Oct. 30 was 9.04%.

COMING FAD. Other fund managers will probably follow Dreyfus in the next year, especially once trading begins in derivative products such as futures and options. Futures contracts indexed to the S&P 400 will trade on the Chicago Mercantile Exchange beginning this spring, and the American Stock Exchange will trade midcap-indexed options.

The concept of midcap investing is hardly new. Vanguard's 15-year-old Index Trust-Extended Market Portfolio is tied to the Wilshire 4500 index. It's called "extended" because it includes many small-cap stocks as well as blue chips. But aggressive growth investors should keep in mind that an actively managed portfolio will generally do better than a "passive" investment that follows an index.

For risk-averse value investors, though, the midcap universe may be an attractive place. "Small and midcap stocks have outperformed blue chips by a lot in the last year, but they're still relatively cheap," says Greg Melvin, vice-president at Federated Investors. The average price-earnings ratio for the S&P 400 is about 21, compared with 29 for the Dow. If the fad continues, investors who jump in before prices overheat could have plenty to be thankful for next year.

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