Despite a disappointing quarter, small-company growth funds envision gains


April 19, 1992|By WERNER RENBERG | WERNER RENBERG,Lipper Analytical Services, Frank Russell Co., Standard & Poor's, funds1992 Werner Renberg

In 24 years of managing Hartwell Emerging Growth Fund, one of the long-term leaders in the small-company growth fund group, John M. Hartwell has seen it all.

The dominant industries may have differed -- computer hardware in the 1970s, health care in the 1990s -- but the cyclical patterns of small companies' stock prices have been similar:

Entrepreneurs who have started new companies or even new industries sell shares of their companies' stock to the public in initial public offerings (IPOs). Alert money managers begin to notice the companies and buy their shares, and the stocks' prices rise. This attracts the attention of more managers and individuals, who also buy, driving prices even higher.

Other entrepreneurs are encouraged to follow, and a tide of addition al IPOs hits a "greedy" market. Early investors start to take profits. Some new companies report poor earnings, or even losses, as competition intensifies, leading other investors to unload when they conclude that the stocks' prices are too high in comparison with the companies' actual or expected financial results. Prices fall until they are judged to be reasonable, when they are bid higher again.

Thus, when his fund reported a 9.6 percent decline for the first quarter of 1992, following an extraordinary 72.5 percent total return for 1991, Mr. Hartwell took it in stride.

"We've had a correction," he says, "I think it's almost over."

In fact, Mr. Hartwell says he believes that small-company stocks, which began to excel in October 1990 after lagging behind large-company stocks for most of the 1980s, will continue to do well for four years or more. But he cautions investors not to expect another year in this cycle as fabulous as 1991: "The best up year is already behind us."

Mr. Hartwell is not alone among small-company growth fund managers in looking back at the first quarter with equanimity and ahead to the next few years with confidence.

To Roy C. McKay, who piloted Scudder Development Fund to a 71.9 percent return last year, the quarter was a period of predictable rotation and profit-taking.

Investors who had scored big with "quality growth" stocks and sold to realize gains put the proceeds to work in "cyclical growth" or "value" stocks.

That helped value-oriented small-company funds and many of the small-company stocks that make up the Russell 2000 Index, but it slowed the momentum of pace-setting growth funds.

Mr. McKay also blames two other factors for the problems faced by growth stocks in the quarter: the rise in interest rates and "a lot of loose lips" among politicians whose rhetoric raised the specter of price controls in fields such as health care.

David D. Alger, manager of the Alger Small Capitalization Portfolio, said health-care stocks also were hurt by "a sit-down strike" by the Food and Drug Administration in approving new drugs: "What looked like a free highway for drugs suddenly got clogged."

The confidence felt by portfolio managers arises from more than statistics and studies, which have shown that over the long run, small-company stocks have outperformed large-company stocks.

Typically, the managers look for companies whose earnings and sales are rising by 20 percent to 30 percent a year.

To deal with the risks inherent in the stocks of small, emerging companies, these managers try to be widely diversified. And when cash builds up, as it has recently, they may take time putting it to work.

But, as we've just seen, their funds tend, nonetheless, to be more volatile in the short run than the overall market, as reflected in the Standard & Poor's 500 Index. Thus, while you may find investing in a small-company growth fund to be rewarding over time, you should be sure you are able to tolerate the risks before putting money into one.

While these funds pay little or no dividends, don't assume that owning shares in one has no current income tax consequences. Because managers are likely to sell stocks that have run up sharply and may not be expected to appreciate more, they realize capital gains. When net gains are distributed to shareholders, they become taxable.

Small-company growth funds

'(Ranked by five-year return)

.. .. .. .. .. .. .. .. .Annual rate of return.. .. year.. .12

.. .. .. .. .. .. .. .. .. .. ..10.. ..5.. ..1.. ..

Fund.. .. .. .. .. .. .. .. .years.. years..year..

Founders Frontier (No load).. .. *.. 19.1%..16.2%.. (3.8%)..0.0%

AAlger Small Cap. (5% R).. .. .. .*.. 18.1.. 12.5.. .(12.0)..0.0

Kaufmann (NL R).. .. .. .. .. .. *.. 17.1.. 36.5.. ..(5.3)..0.0

Janus Venture (NL X).. .. .. .. .*.. 16.8.. 18.6.. ..(3.0)..0.4

Oppenheimer Disc. (5.75%).. .. ..*.. 15.5.. 37.5.. ..(3.6)..0.0

AHartwell Emerging Gr. (4.75%).18.0.. 14.2.. 25.5.. ..(9.6)..0.0

Calvert-Ariel Growth (4.75% X).. *.. 14.1.. 14.5.. .. .0.7..1.9

Fidelity OTC (3%).. .. .. .. .. .*.. 13.5.. 22.9.. ..(1.4)..0.5

Sit "New Beginning" Growth (NL)..*.. 12.9.. 20.4.. ..(9.2)..0.5

AScudder Development (NL).. .. 14.6.. 12.9.. 26.8.. ..(9.0)..0.0

AAmer. Cap. Emerg. Gr. (5.75%).15.4.. 12.9.. 25.0.. ..(5.5)..0.1

AAcorn (NL X).. .. .. .. .. .. 18.6.. 12.9.. 34.0.. .. .5.5..1.0

Group average.. .. .. .. .. ..14.8.. 10.0.. 22.8.. ..(0.7)..0.5

Russell 2000 Index.. .. .. .. 14.4.. .6.1.. 21.0.. .. 7.5a..1.6a

Standard & Poor's 500 Index.. 18.1.. 10.4.. 11.1.. .. (2.5).a 3.0a

R = Deferred sales or redemption charge; X = Closed to new investors

* Not in operation for all of the period

** As of April 9, 1992

*** Income dividends paid during previous 12 months, divided by latest net asset values.

Note: Excludes funds not generally available to individual investors or with assets below $25 million.

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