A bet on growth puts small-cap funds ahead in 1Q

Investors are betting that small-caps will be the stock market’s standouts as the economy improves.

Some of the strongest mutual fund returns in the January-March quarter have come from funds that focus on smaller companies.

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Small-capitalization value funds returned an average 9.3 percent and small-cap growth funds returned 7.2 percent during the quarter. The numbers topped the 3.7 percent return for large-cap growth funds and the 5.3 percent return for large-cap value funds. The figures reflect trading through Thursday so they don’t include the final four trading days of the quarter.

Value funds invest in companies that are considered undervalued and that are expected to pay dividends. Growth funds concentrate on stocks that are expected to post strong gains in price but aren’t likely to hand out dividends. Many small companies are considered growth stocks because they shovel their cash into expanding and aren’t as likely to have a long history.

The change in small-caps’ fortune comes from investors’ growing appetite for risk. Small-caps were in the dog house during the recession because many investors believed they had fewer resources than bigger companies to withstand hard times. But small-caps are considered more agile when business starts looking up.

That vaulted small-cap funds ahead of most large-cap funds in the first quarter, according to fund tracker Lipper Inc.

A popular measure of small-caps, the Russell 2000 index, shows how well that market segment has done. It’s up 8.9 percent so far this year, including dividends. By comparison, the total return of the large-cap Standard & Poor’s 500 index is 5 percent.

Overall, the stock market is climbing at a slower pace than it had for much of 2009, when major stock indexes rocketed off of 12-year lows. But for many analysts, a slowdown is just fine.

Linda Duessel, equity market strategist at Federated Investors in Pittsburgh, said the relatively subdued advance means the market is more likely to hold its gains instead of racing higher and then crashing.

“You don’t want a blowout. It’s going to blow up later,” she said.

Funds put up first-quarter numbers that were impressive even though the market’s pace has slowed. Diversified U.S. stock funds posted an average return of 5.3 percent. These funds often have an array of holdings and don’t focus on a single industry.

Still, many analysts remain cautious. Channing Smith, co-manager of the Capital Advisors Growth Fund in Tulsa, Okla., said investors shouldn’t be too quick to dump big companies. He said the strongest large-cap companies are going to hold up much better than small-cap names if the economic recovery unravels.

He said investors need to have a plan that will help them gain from some of the advances in stocks but still allow them to shift into more cautious investments if the market tumbles again.

“You need to understand what’s happening in the short-term but you need to have your hand on the ripcord,” Smith said.

It could be hard for some investors to let go of some of the strongest funds from the first quarter.

Financial-services funds posted an average return of 11.5 percent. Stocks of banks and other financial companies led the market down during its plunge but have also led the nearly 13-month rebound.

Real estate funds returned 11 percent for the quarter. The funds mostly hold shares of real-estate investment trusts. REITs invest in commercial property and some apartment buildings. They pass along most of their income to shareholders through dividends.

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