Small-Cap Funds Max Out

While she declines to discuss individual stocks in the small-cap arena and says it's dangerous to make too many generalizations about a universe of 5,500 companies, Lisanti believes that small-cap tech stocks valuations "are a little rich," though some niche players, particularly in software and chip manufacturing, are good buys.

"Forecasting small companies' growth rates is more of a black art than a science," she says.

And that art -- witchcraft or not -- doesn't come cheap.

Expense ratios for actively managed funds are relatively high, with some charging as much as 2.5% per year and others settling around 1.7%.

But Robert Pagliarini, a financial planner in the Los Angeles area, says that small-cap funds are one area where the manager makes all the difference.

Because large-cap funds invest in many of the same stocks, it's the small-cap, often bottom-up research efforts that can find an unexpected upside.

"It's hard for large-cap funds to beat their benchmarks, especially after fees," he says. "When there are fewer analysts covering smaller companies, we like an active approach" that can still make an investor money beyond conventional benchmarks. "Any time you're dealing with an active manager, you've got to pay his salary."

Taking a value approach, Pagliarini likes to allocate 10% of his clients' portfolios to the Third Avenue Small Cap Value Fund (TASCX). Already up 4.43% this year, the no-load fund has a 1.17% expense ratio.

Pearson, the Virginia Beach financial adviser, isn't averse to upping a client's small-cap allocation to as much as 20%, particularly coming out of a recession.

He says micro-cap stocks remain a favorite, even if some of his favorite funds are closed and finding new ones for his clients is a tougher task as the small- and micro-cap buzz keeps going. "That's causing me to stay on my toes," he said.