Two Ways to Approach Smaller-Cap Growth

If you could magically remove the final months of 2000, it would look like a great year for many small- and mid-cap growth funds. But as tech stocks sank in the fourth quarter, so did many of these funds.

Ultra-aggressive small- and mid-cap growth funds--from families such as Van Wagoner, PBHG and Janus--were pummeled in the final three months after enjoying fantastic gains earlier in the year.

So, to do well in 2000, a fund had to avoid brutal fourth-quarter losses--and to do that, it had to be light on tech stocks late in the year.

That means investors looking for promising small- and mid-cap growth funds for 2001 and beyond have a fundamental decision to make: Do they buy funds with low tech stakes and risk missing out on juicy gains if a momentum-driven market environment returns?

Or do they go bargain-hunting for fallen go-go funds, figuring the best time to buy is after a major dive--especially in an environment of falling interest rates?

Investors researching small- and mid-cap growth funds will find plenty of choices in both camps.

Consider T. Rowe Price Mid-Cap Growth. A year ago, this $6.5-billion fund was floundering near the bottom of the mid-cap growth category because of its modest tech-stock exposure. But that limited tech stake (now 25%) put the fund into the top quartile of its sector for 2000: It was up 7.4% for the year after losing just 3.8% in the fourth quarter.

Manager Brian Berghuis has kept risk low compared with his momentum-driven competition. Yet the fund sports a respectable long-term record. Its three-year average annualized return is 18.6%, compared with the category average of 21.8%.

On the other side is Van Wagoner Mid-Cap Growth. Manager Garrett Van Wagoner may be the biggest gunslinger in the mid-cap growth field. This fund soared in 1999 as techs rocketed, finishing the year up 127%. In the first nine months of 2000 it was up 33.7%.

But the fund shriveled in the fourth quarter because of its brazen 91% tech weighting. Only seven funds--including two others run by Van Wagoner--skidded more in the fourth quarter than the 42.6% lost by Van Wagoner Mid-Cap Growth, according to Morningstar.

When the market is going his way, Van Wagoner can score truly awe-inspiring returns. But the price is overwhelming volatility.

With the fund more than 50% off its March high, is now a good time to buy? Perhaps. But “you can’t delude yourself into thinking it’s hit a bottom, because with a Van Wagoner fund it’s always capable of losing another 50%,” warned Russ Kinnel, Morningstar director of fund analysis.

In the small-cap field, Columbia Small Cap has been less aggressive than many of its small-cap peers, and that caution paid off in 2000. Lead manager Richard Johnson lightened up on a then-sizable tech stake beginning in February, when he became worried about valuations. Modest tech exposure--currently at 31% of the portfolio--kept the fund’s fourth-quarter loss to a moderate 9.3%, which helped Columbia Small Cap to a gain of almost 6% for the year.

The fund has held up well in market sell-offs compared with its peers.

In the micro-cap sector--funds that own the smallest of small stocks--Bjurman Micro-Cap Growth showed shrewd timing last year: It loaded up on tech stocks when they were rising, and then sold many of them before the year-end tech blood bath.

The fund, run by Los Angeles-based George D. Bjurman & Associates, rode the tech frenzy to strong gains in 1999 and the first quarter of 2000. Early in 2000, its tech weighting topped more than 70%. But manager Thomas Barry cut that back as techs started falling and today he holds a modest 24% in tech, according to Morningstar.

Though the fund’s tech foray shows it is willing to take big risks, Barry said in a recent interview that he tries to minimize losses by selling stocks at the first whiff of trouble in a firm. That strategy carries a price tag, though, for investors in taxable accounts: Annual portfolio turnover is a whopping 337%, according to Morningstar.