Selected small-caps make a big noise

When it comes to investing this year, small has been - and remains - beautiful. And, for now at least, that trend does not appear to be easing.

Throughout the year, funds that invest in the stocks of small companies have led the market, but with one important caveat: The small-cap funds that have surged fit into the value and blend categories. Small-cap growth funds have tended to lag the market.

Certain stock market indexes quickly tell the tale. Of all the domestic stock groupings monitored by Standard & Poor's, the only group up for the year is the S&P 600 small-cap index. All the other indexes, the large cap S&P 500 index, the S&P 1500 (total market) index and the S&P 400 mid-cap index, are down for the year.

For typical investors seeking to eke out gains for their often battered mutual funds, the issue of what happens next for small-caps is hardly a minor concern. After all, if not small caps, where do mutual fund investors go to post returns in the equities arena?

Information firm Morningstar Inc., based in Chicago, was asked to run a cursory computer search to see if, in fact, the glow is fading from small-cap funds.

But the opposite may be true. Small-cap funds, for now at least, appear to be getting better.

For the period from Jan. 1, 2001 to April 30, according to Morningstar, small-cap value funds were up over 7 percent. Small-cap blend funds were up 2.5 percent.

Only small-cap growth funds were down, about 9 percent.

During that same period, large-cap growth funds were down 12 percent, large-cap blend funds were down 6 percent, and large cap value funds were down 0.2 percent.

Now, fast forward to the period from Jan. 1, 2001 through July 31, three months later. Has small finally lost its muscle?

Not hardly.

Through July 31, based on preliminary figures, small-cap value funds were up almost 13 percent; small blend up 6 percent.

Only small growth was down, about 8 percent.

Compare that to large caps: Large-cap growth funds were down almost 19 percent; large blend funds down 10 percent; large value down 1.4 percent.

In other words, small kept gaining, while large kept losing.

Arnold Kaufman, editor of "The Outlook," an analytical review published by Standard & Poor's, still finds steady gains in small-cap stocks. But he also sees future gains in mid-caps.

Small-cap value stocks continue to outperform the market, he notes, a trend he does not see ending anytime soon. And looking ahead, mid-cap stocks look increasingly attractive, he says.

"Many mid-cap firms have the characteristics of large-cap companies, yet without their drawbacks," he says.

Unlike bigger companies, few mid-cap firms have overseas exposure. So they tend to avoid currency exchange problems, which can cut into returns.

Mr. Kaufman also likes mid-cap stocks because of their relative obscurity.

"Mid-cap stocks ...tend not to be covered by most securities analysts," he says. But the analysts who do cover them tend to find many solid, well-performing companies with attractive valuation levels.

Still, many market watchers say it may be time to start shifting some assets into large-cap stocks, as the economy moves into higher gear later this year or early in 2002.

"Our market strategist here sees a bottoming taking place in the stock market," says Larry Wachtel, a vice president with Prudential Securities, in New York.

That means, he says, that it is important to start looking toward new flight-paths for one's investment dollars.

"Part of the problem is capitalization. There is not enough [liquidity] in the small-cap sector to place all the new money that will be directed back into the market as the economy rebounds," he says.

"To place a lot of new money, managers will be forced to look to the large-cap arena," adds Mr. Wachtel.

Large-cap sectors he likes are pharmaceuticals, technology (such as Intel and Texas Instruments), and large machinery companies, such as Caterpillar and Dow Chemical.