Big Score for the Little Guys

Small- and mid-size stocks now look like the ones to beat after a third-quarter comeback led by the tiniest of the tiny.

They're back - and whooping it up in the end zone.

Through most of the 1990s, large-company stock funds dominated the mutual fund game. But in a comeback worthy of the Gipper, small-company stocks snatched the ball from their bigger rivals and ran downfield for a table-turning third-quarter touchdown.

After several years of lagging the market, it looks as if small-cap funds may finally come out ahead in 1997. They hopped ahead 16.6 percent from July to September, doubling the returns of the major indexes.

Hottest of all were micro-cap stocks - companies valued in tens of millions, not billions, of dollars. They surged 24 percent for the quarter.

Munder Micro Cap Equity Fund (800-438-5789; minimum investment, $500.) soared a sizzling 78 percent in nine months by investing in the likes of Great Plains Software, Racing Champions Corp., which makes miniature products for racing aficionados, and Hamilton Bank, which finances international trade.

And fund manager Carl Wilk sees more lively music ahead.

He is far from alone in that assessment. Several factors make small- and mid-cap mutual funds the ones to beat in the fourth-quarter and early 1998, many analysts say.

Among the key trends:

* Low interest rates. They lower borrowing costs for smaller firms. And the Federal Reserve seems reluctant, for now, to raise rates.

* Cheap prices. The roaring stock market has lifted stock prices for large companies to all-time highs. Many analysts think smaller stocks are ready to play catch-up (but some disagree).

* Better profits. Many large firms have watched profit margins shrink, as a soaring US dollar takes the edge off their international earnings. But smaller companies are generally rooted on home shores, which means minimal impact from the dollar.

* Tax reform. A recent cut in capital-gains taxes favors stock investment in general, perhaps especially small-cap firms.

"There's definitely a bias now favoring small and mid-sized companies," says Eric Wiegan, who oversees $200 million in mid-cap assets at First Capital in Philadelphia.

Mid-cap companies usually have a market capitalizations (share price times the total number of shares) of $500 million to $5 billion.

Small-cap firms weigh in at $500 million or less, often well under $100 million.

Micro-cap firms are the smallest of the small caps, at $50 million or less.

The year started poorly, however, for small caps. The sector bottomed on April 30, says Munder manager Wilk. But during the lean months, he and many other managers bought their favorite stocks at depressed prices. Wilk bought shares in 80 of the portfolio's 100 or so companies.

"We're not making bets on any one company or any one sector. We're acquiring positions" in lots of industries, he says, both for gains and for reducing risk.

"Diversification is now very important," for investors in general, says Stephen Savage, an analyst at Value Line in New York.

He says investors should consider 35 to 50 percent of their US stock position small or mid caps, depending on their tolerance for risk. More conservative investors might aim lower, 10 to 20 percent.

Mr. Savage notes that small-cap stocks have outperformed large caps over the long run, since 1929. Although a study by Jeremy Siegel at the University of Pennsylvania, finds that the gap stems entirely from the 1974-83 period.

In nine of the past 13 years, large caps beat small caps, says Sheldon Jacobs, editor of the No-Load Investor in Irvington-on-Hudson, N.Y. "There is nothing that would inherently justify projecting" small cap dominance into the future."

Savage likes Neuberger & Berman Genesis (800-877-9700, minimum investment: $1,000, $250 for an IRA), and Acorn (800-962-1585; $1,000 minimum investment, IRA, $200.) Genesis, a small-cap growth fund, rose 40 percent in nine months; value-style Acorn is up 26 percent.

Although value funds have outperformed growth funds during most of this year, the two styles are apt to move into equilibrium over time, Savage says, as smaller growth funds catch up.

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