Heroics are often difficult to repeat

Some history is useful in trying to select a small growth fund

Dollars & Sense

May 27, 2001|By Russel Kinnel | Russel Kinnel,MORNINGSTAR.COM

Trying to pick a small growth fund? Good luck. Of our 44 categories, this could be the most challenging to pick from. For proof, look at the heroes of 1996: Of the small growth funds that produced top-quartile returns in the five-year period ending May 1996, not one was able to repeat that feat in the next five years.

Of the 10 funds with the highest returns, only one, Delaware Trend, managed to beat the category average. American Century Giftrust and Seligman Frontier, actually lost money over the entire five-year period from 1996 to April 2001. Each of the 10 has a slightly different tale, but there are common themes.

Manager changes: Eight of the top 10 funds were hit with manager changes over the past five years. Team-managed AIM Aggressive Growth has had four co-managers leave over the past 10 years. American Century Giftrust had eight.

Asset bloat: Looking at yearly asset totals, you can see a few of these funds get stopped dead in their tracks by asset bloat. Small growth funds' agility is crucial because they need to get in and out of stocks fast. Federated Kaufmann put up great numbers from 1992 through 1996, but assets went from $313 million to $5.3 billion over that period and the fund hit a wall. It underperformed in each of the next three years. AIM Aggressive grew from $38 million to $2.7 billion over that same period, and returns began heading south in 1996.

Change in focus: Given the manager and asset changes, it's no surprise that some of these funds have entered different investment universes. Four of the 10 are now mid-growth funds, though Delaware Trend is to the low end of mid-cap. Two other funds have had their focus changed to the point that they're no longer with us. Hancock Special Equities was merged into Hancock Small Growth - which has actually performed respectably of late. Parkstone Small Cap merged into Armada Small Growth in June 2000. Armada has performed poorly since, but that's a very short time period to judge them by.

Lack of IPOs: Related to the asset-bloat issue is the fact that IPOs can't contribute much to a big fund. Fund companies get a small allocation of hot IPOs, and those shares can give a tiny fund some pop, but that's just a drop in the bucket when a fund has $1 billion in assets.

We'll have to look at more time periods before we have something definitive on small growth. But the way small growth funds behave suggests a few prudent rules for investing in this space: First, you might want to be quicker on the trigger with small growth funds just as small growth managers are quicker to sell stocks than are managers in other asset classes.

Second, past total returns seem to have less predictive value here, so give them less weight in your selection process than you would with other fund categories. Instead, look for a good manager and a fund that will close under $1 billion.

Third, if you can't find a small growth fund in which you have a lot of faith, work the edges. You can get exposure to small growth stocks or stocks like them by investing in mid-growth funds or small-blend funds.

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