Small-Cap Funds Max Out

On a total return basis, the Russell 2000, a benchmark index for small-caps, is up 5.28% for the year to date. It surged 64.41% in 2003 and it has a five-year total return of 9.79%, according to its Web site. On the same basis, the S&P 500 is up 3.25% for the year to date, but lags well behind the Russell with a 12-month return of 38.53% and a five-year return of 0.12%.

Because there are more than 5,500 small-cap stocks, good managers can still find upside, but that's getting tougher, according to Kerry O'Boyle, a mutual fund analyst at Morningstar.

"We're trying to make people aware that small-caps have had a really good run and it's not likely to last too much longer," he says. "It's a good time to rebalance if your small-cap funds have gained a lot. It's not time to ditch your small-caps, but it's not a good time to dive in with too many assets into that group with such a big run-up."

O'Boyle says the widely held notion that small-cap stocks behave cyclically may have some merit. Coming out of a recession, smaller companies show more dramatic earnings growth and faster appreciation in their share prices. But if the current rally isn't as deep as the bulls think, and investors grow wary, those same companies will be the first to take a hit.

"If there was any sort of pullback, small-caps might be beat up pretty hard," O'Boyle says.

But confident managers aren't shying away from their preferred strategies. Mary Lisanti, who just launched the Adams Harkness Small Cap Growth Fund, says there's still ample room for finding an upside.

"Small-cap cycles tend to be long," she says. "This cycle has been led by financials, and this kind of disparity generally doesn't last. It's been led by financials because the Fed has lowered interest rates so many time in the last few years. Now you're getting a broader-based rally."