The Junkie's Small-Cap Growth Fund Picks

Today's Fund Junkie features three sections on the best funds for growth investing: Big-cap growth funds, mid-cap growth funds and small-cap growth funds.

Small-cap growth funds, which shop among young shops with volatile stocks, have taken investors for quite a ride. They gained more than 61% on average in 1999, but are down more than 36% over the last 12 months. Here are five funds that haven't always risen as high as their peers, but don't typically fall as far, either.

Small-Cap Growth Favorites
Fund	1-Year Return	3-Year Return	5-Year Return
(ACRNX)Liberty Acorn	1.2%	10.7%	16.3%
(WAAEX)Wasatch Small Cap Growth	-3.1	13.6	14.8
(BGRFX)Baron Growth	-13.2	6.4	14.5
(VEXPX)Vanguard Explorer	-19	8.7	11.7
(MGSEX)Managers Special Equity	-29.6	6.9	14
Avg. Small-Cap Growth Fund	-36.7	2.9	8.7
Source: Morningstar. Returns through March 19.

Like the wallflower who sheds his glasses and shows everyone he's dangerous on the dance floor, these tech-light funds didn't look too hot in 1999 but are looking great now. Unlike most of their peers, they stuck to a more diversified approach and didn't egregiously overweight the tech sector -- and that has led to a lot less risk. If we build a portfolio of these five funds, we find that its worst 12-month loss would've been a 17.1% tumble, compared to 30.6% for the average small-cap growth fund.

In running the broker-sold (ACRNX)Liberty Acorn fund, co-managers Ralph Wanger and Chuck McQuaid follow a price-sensitive approach and spread the fund's big $3.9 billion asset base among some 250 stocks. Instead of focusing strictly on tech, their biggest overweightings are in the financial services and telecommunications sectors. This methodical approach has led to solid results: The fund has beaten at least 80% of its peers over the past one-, three-, five- and 10-year periods, according to Morningstar.

Of course, there are some potential concerns, too, with this fund. Wanger recently sold his firm to Liberty Funds, which slapped loads or sales charges on shares for new investors, and he's only under contract to stay for five years. Also, the fund's large asset base could limit its flexibility in the less liquid small-cap market -- though its diversified strategy makes this less of a concern.

Jeff Cardon, manager of the no-load (WAAEX)Wasatch Small Cap Growth fund since its 1986 inception, has quietly built a solid track record. Cardon focuses on mercurial sectors like health care, telecommunications and technology, but the fund didn't have any down years in the 1990s or last year. The fund beat at least 80% of its peers over the past one-, three-, five- and 10-year periods, according to Morningstar.

Additional pluses are the $260 million fund's modest size and Salt Lake City-based Wasatch's focus on small-cap investing.

The (BGRFX)Baron Growth fund is also intriguing, if a bit more risky. Ron Baron has run the no-load fund since its launch at the end of 1994, and he focuses on companies where he thinks savvy management will lead to rising earnings and stock returns. The approach has worked well, as the fund's 14.1% five-year annualized return beat more than 80% of its peers.

But Baron isn't shy about making bets. He tends to take big positions and hold them for a long time. At the end of last year, Baron had almost half the fund's assets sunk into the fund's top 10 holdings. In the less liquid small-cap market, it can be tough to unwind a big position that isn't working out, which can lead to volatility in the short-term. Though the fund beats its average peer over the last one-, three- and five-year periods, it did trail the pack in 1998 and 1999.

The last two funds on our list both spread their assets among a cadre of solid money management firms with a range of different styles. This diversified approach has led to solid returns with less volatility, as both funds have suffered less than their average peer in down months over the past three years.

The no-load (VEXPX)Vanguard Explorer is run by five different firms, blending index-tracking and actively managed small-cap investment styles. That's meant a vast portfolio of more than 800 stocks, which might have led you to expect humdrum returns, but that hasn't been the case. Because the fund's diversification has helped it weather the market's storm better than its more aggressive and tech-heavy peers, its record is sparkling. It beats at least 70% of its competitors over the past one-, three-, five- and 10-year periods, according to Morningstar.

The no-load (MGSEX)Managers Special Equity fund, which I own, is run by four different firms, each following a distinct growth- or value-oriented approach in the micro- and small-cap markets. This fund also has a long list of holdings, almost 300 stocks at the end of last year, and a consistently solid track record. The fund has beaten at least 65% of its peers over the past one-, three-, five- and 10-year periods, according to Morningstar.

If you're looking for a more aggressive small-cap growth fund, you might want to check out the no-load (RSDGX)RS Diversified Growth fund, co-managed by John Wallace and John Seabern. Wallace's name might ring a bell because his (RSMOX)RS MidCap Opportunities fund turned up on my list of good mid-cap growth funds.

These managers aren't shy about taking risks. They focus on stocks of the fastest-growing companies in the market's fastest-growing sectors. As you might imagine, that led them to a hefty helping of tech and telecom stocks, which hit the fund hard. It's lost a bit more than half its value over the past 12 months, trailing almost 90% of its peers. That's bad, but the fund did trounce its peers in 1997, 1998 and 1999. Its 16.3% three-year annualized return beat just about all of its competitors, so there is reason to think Wallace and Seabern can get back on track.

For most investors, the slower, steadier approach practiced by the funds on my list is probably a bit more appealing now that we know how far aggressive funds can fall.

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