Small caps in limelight, at least for now 'Less of a rotation than I expected'

Mutual funds

October 12, 1997|By Jerry Morgan | Jerry Morgan,NEWSDAY

Small- and micro-cap mutual funds outpaced their large-company peers in the third quarter, but whether that was the start of a stock market move from blue-chip stocks or simply one terrific quarter for small stocks remains to be seen.

"It is less of a rotation than I expected or would like to see," said Arnold Kaufman, editor of Standard & Poor's Outlook investment advisory newsletter. "Though the trend toward small-cap makes sense, I would expect it would become even stronger if the [large-company] market flattens out."

Many blue chip stocks were stung by the strong dollar, which cut those companies' overseas earnings, as well as capital-gains tax cuts that favor smaller company stocks and a resurgent technology market that has pushed the Nasdaq index to new records.

Those factors helped push micro-cap funds -- those that invest in companies with the smallest capitalizations -- to a gain of 24.25 percent in the quarter and small company funds to 16.55 percent. S&P 500 index funds, on the other hand, gained 7.33 percent. Overall, Lipper's average of nearly 3,000 general equity funds gained 11.82 percent.

Part of the switch may be a normal market move, or rotation, away from the S&P 500 stock index, whose 113 percent gain from December 1994 to its Aug. 6, 1997, peak was the best performance since Standard & Poors started keeping numbers in 1928, Kaufman said. That gain was also a huge boost to the passively managed funds that track the 500 index. Those index funds attracted billions of dollars in new money.

Now, perhaps the recent success of actively managed small-cap funds -- which really began in April -- means "that maybe active managers weren't as dumb as they looked three months ago and maybe they aren't as smart as they look now," said Don Phillips, president of Morningstar Inc., a Chicago mutual fund ratings company.

"There are a lot of managers who seem to be skeptical and concerned that this is not just another good quarter. They would love nothing more than to say small cap is back, but that has fizzled before," Phillips said.

"You could argue that investors were getting afraid of the blue chips and so they moved to small caps," said Matthew Muehlbauer, research manager of Value Line Mutual Funds in New York. "More people have been buying the small caps over the summer, and actively managed funds are outpacing passively managed funds."

Blue chip stocks still have their backers, such as foreign investors and institutional managers who like those companies because they are much easier to sell than many small-cap companies. But Robert Froehlich, chief investment strategist for Zurich/Kemper Funds in Chicago, said there are reasons for the change.

"The rotation began with the capital-gains tax cut, which serves to turbo-charge the small-company stocks because investors are not looking for dividends but for capital appreciation," he said.

Froehlich also cited a feeling that interest rates aren't headed upward and the continuing strong economic outlook as reasons for the growth in small-stock prices.

How deep the move is, time will tell. "It is more the professionals taking profits and moving into the small caps than individuals," Kaufman said, and the professionals are still reluctant to cash out the gains made in blue chip and index funds.

Pub Date: 10/12/97

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