History has shown that the bull market in large-cap stocks doesn't run on endlessly--and that over the very, very long haul, investments in small-cap stocks pay off the most.
Over the years, small-cap stocks -- those companies with a market capitalization of less than $1 billion --have rewarded investors handsomely: Between 1926 and the end of 1997, while large-cap stocks returned an average 11 percent per year as measured by the S&P 500 Index, small-cap stocks returned 12.7 percent, according to Chicago-based equity research firm Ibbotson Associates.
Including both large- and small-cap funds in your investment strategy makes good sense, especially for those who want to create a diversified portfolio. The State Street Research Emerging Growth Fund has been around for nearly five years, and J.C. Cabrera has been its manager since 1997. At the end of March, the fund was up 15.87 percent, well ahead of the average small-company fund return of 10.9 percent for the first quarter of this year.
Cabrera believes it's a great time to invest in small-company growth stocks. He uses the Russell 2000 Growth Index, which follows the performance of small-cap growth stocks, to make his point. He says that in 1998, earnings for S&P 500 stocks are expected to grow at between 5 percent and 6 percent. "Russell 2000 stock earnings are expected to grow at about 15 to 16 percent," he says. "That's a threefold better growth rate in the small-cap sector."
There are about 125 different stocks in the State Street fund. The fund holds a high number of companies to help manage volatility. "Investing in small caps is by nature riskier than investing in large-cap companies," explains Cabrera, a 14-year veteran of the securities industry. To provide additional risk management, the fund also takes the time to learn all it can about the companies it invests in and diversifies its holdings among industry sectors.
The companies that make it into the State Street fund are those that have demonstrated dynamic revenue and earnings growth rates as well as revenue stream predictability. These companies may have one or two core products in the market that are selling very well, plus a few others waiting in the wings.
Holdings that represent Cabrera's portfolio management style include Biovail Corp. International, a pharmaceutical company with revenue and earnings growth in excess of 35 percent; Total Renal Care, which operates dialysis centers; and Steiner Leisure Ltd., which runs health spas on cruise ships such as Carnival Cruise Lines, Norwegian Cruise Lines and Royal Caribbean.
Because today's small-cap businesses may become the big-cap companies of tomorrow, the question for fund shareholders might change from "Should I own small-cap stock funds?" to "How much should I own?" The answer, of course, depends on your tolerance for risk.
Dian Vujovich is a nationally syndicated mutual fund columnist and author of Straight Talk About Mutual Funds (McGraw-Hill), Straight Talk About Investing for Your Retirement (McGraw-Hill), and 10-Minute Guide to Stocks (Macmillan).