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Investment Consult


Time to rethink small-caps

Time to rethink small-caps

Stocks of small- and mid-sized companies have given investors plenty of reason to celebrate in the past few years, often delivering returns that soundly beat the S&P 500's. Unfortunately, the champagne may finally be going flat.

Based on a review of my clients' portfolios and feedback from value fund portfolio managers whom I respect, small- and mid-cap stocks have lost most or all the price edge over large-caps that helped fuel their impressive returns. Many value fund managers tell me they're now having trouble finding stocks that meet their investment criteria. As a result, some top-performing funds—including Royce Opportunity, which was up almost 73 percent in 2003, and Strong Advisor Small Cap Value, which returned nearly 49 percent—have closed to new investors.

If your portfolio has a heavy concentration of small- and mid-cap stocks or funds, now's the time to remember the importance of diversification. To lessen your portfolio's overall risk, you need to spread your bets; your money should never be concentrated in one market sector, company size, investment style, or in one mutual fund.

That doesn't necessarily mean you should start selling small- and mid-caps in droves. It's best to make changes patiently and gradually. But if you don't start cutting back now, a drop in the market could scare you into bailing out hastily and choosing inappropriate alternatives.

When shifting cash out of small- and mid-caps, avoid the temptation to reinvest it in technology and speculative areas of the market that have been performing especially well recently. Right now, mutual funds that invest in large-cap stocks, particularly large-cap growth stocks, offer more reasonable opportunities. In general, the amount you keep in small- and mid-caps should be smaller than the amount you hold in large-caps—significantly smaller, if you're conservative.

For extra protection, invest in mutual funds that seek companies whose price growth is reasonable relative to earnings. I recommend Legg Mason Value Trust (800-577-8589) and Selected American Shares (800-243-1575). Bill Miller, who manages the Legg Mason fund, has beaten the returns of the S&P 500 for 13 years in a row. Over the 10 years through June 30, the fund returned an annualized average of more than 18 percent, which places it at the top of its class. Selected American Shares, which has been in existence since 1933, is another fund that has delivered consistent results to investors; it has returned more than 14 percent annually over the same period.

In addition, bump up your position in international funds. Foreign-based companies may be able to grow their earnings faster than their US counterparts can in the post-presidential-election environment. Harbor International Fund (800-422-1050), which invests primarily in large companies, is a good choice. It boasts seasoned management that takes a disciplined, patient approach to foreign investing.

And, as I advised a few months ago, save some money for Japan. (See "Japan: Land of the rising stocks?" May 21, 2004.) One fund I didn't mention then is SPARX Japan Fund (800-632-1320). I usually don't recommend funds until they have a three-year performance record, but I'm making an exception for this one, which opened last October. It's run by Shuhei Abe, a smart, veteran stock picker who has managed Japanese equity investments for Soros Fund Management and Credit Suisse First Boston. SPARX Japan Fund is worth considering on his talent alone.

The author, a fee-only financial planner, is president of L.J. Altfest & Co. (, a financial and investment advisory firm in New York City, and an associate professor of finance at Pace University. The ideas expressed in this column are his alone, and do not represent the views of Advanstar Medical Economics. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics, 5 Paragon Drive, Montvale, NJ 07645-1742. You may also fax to 973-847-5390 or e-mail to


Lewis Altfest. Investment Consult: Time to rethink small-caps. Medical Economics Aug. 20, 2004;81:14.

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