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Bigger hasn't been better for stocks this year, as the widely predicted rotation from small-cap to large-cap leadership has failed to materialize.

But analysts say investors will only suffer greater frustration if they purge their large-cap holdings and abandon the concept of asset allocation.

There is a firmly held belief among analysts that small- and mid-cap stocks, or companies with market capitalizations below $10 billion, outperform large-caps in the early stages of an economic recovery due to their flexibility. In the case of the most recent recovery, that view has borne out as small-cap returns have

walloped those of the heavyweights. The

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exchange-traded fund rose 38.5% in 2003, more than 10 percentage points better than the


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ETF, which tracks 500 of the largest companies in the U.S.

Large-caps, which have market values north of $10 billion, traditionally take the leadership baton a little later in the recovery cycle because it takes more time for the big guys to wake up and hire additional workers, restock inventories and crank up production to meet consumer demand.

But those sleeping giants seem to have hit the snooze button once too often. Year to date, large-cap growth funds have returned a negative 3.48%, making them the fourth worst-performing fund category and more than doubling the losses of the average small-cap growth fund. And large-cap blend and value stocks have also spent the year trailing their tiny counterparts when they should have outpaced them by now, especially as the second year of the recovery comes to a close.

The inability of large-cap stocks to play catch-up is causing angst among a growing number of investors. But financial advisers say stay patient and don't cash in those blue chips.

"Large-cap growth stocks have been hurting for so long, people are asking why they need them anymore," says Susan Stiles, financial adviser at Minnesota-based Stiles Financial Services. "They want to sell them so they can increase their small-cap exposure, but that defeats the purpose of asset allocation."

Asset Allocation

Asset allocation means dedicating certain percentages of your holdings to broad asset categories like stocks, bonds, real estate and cash in a way to achieve your financial goals while minimizing risk. The strategy works because asset classes behave differently. Stocks, for example, offer long-term growth and income while bonds provide stability and income.

It was also a concept forgotten or just plain ignored during the tech boom of the late 1990s, when many investors concentrated all their assets in volatile tech stocks -- only to see their holdings plunge in value.

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An individual's asset allocation is determined by their investment goals, time frame and risk tolerance. To further reduce risk, financial advisers suggest diversification within asset categories. In the stock category, that means separating stocks by market capitalization and considering the foreign vs. domestic divide.

Investment research firm Morningstar, for example, suggests possible asset allocations for three different types of investors: aggressive, conservative and moderate. They recommend an aggressive mix for risk-tolerant investors with financial goals (retirement, college) more than 10 years away. In their eyes, an example of an aggressive portfolio would consist of no cash, 15% bonds, 55% large-cap stock, 17% small-cap stock and 13% foreign stock.

Morningstar's moderate mix is for investors with a five- to 10-year horizon who can stomach a reasonable amount of risk. That portfolio comprises 15% cash, 35% bonds, 32% large-cap, 10% small-cap and 8% foreign stock.

And if your goal is less than five years away or if you can't tolerate much risk, Morningstar has a conservative allocation of 60% cash, 25% bonds, 10% large-cap, 3% small-cap and 2% foreign stocks.

The Large-Cap Piece of the Pie

Asset-allocation guidelines like those suggested by Morningstar are important for investors looking to assess their risk tolerance and goals. But sooner or later they have to take the final step of choosing the stocks or funds to fill each piece of their investment pie.

When it comes to the large-cap portion of his clients' asset allocations, Scott Whyte, financial adviser with Michigan-based Bloom Asset Management, says he opts for mega-cap funds -- those holding stocks with market values above $30 billion. He looks for low turnover to minimize tax consequences.

"Large-caps, especially the mega-caps, are less dynamic than small-caps and that helps on taxes because the fund manager does not have to trade a stock that grows too quickly," says Whyte, whose favorite funds include the

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Jensen fund and the


American Funds Growth Fund of America.

He also subdivides his large-cap holdings into three segments, preferring to overweight value stocks at 40% compared with growth and blend stocks at 30% each.

Tim Medley, financial adviser at Mississippi-based Medley & Brown, on the other hand, doesn't make a distinction between value and growth in his large-cap portfolio, though he says he eventually finds himself in value funds anyway.

"We simply look for great managers with stellar track records," says Medley. "Generally that leads us to value funds since long-term research says value outperforms growth."

Some of the large value funds Medley puts his clients in include the

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Oakmark I fund managed by Bill Nygren and the

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Torray fund.

If an investor is looking to put more than $100,000 to work, Mary Rinehart, a financial adviser at North Carolina-based Rinehart & Associates, says she will buy her client individual equities, not funds, to fill out the large-cap part of their portfolio. She says dealing with lots of fewer than 100 shares makes trading difficult.

For investors below the $100,000 level, she relies on the

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Buffalo U.S.A. Global fund and

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Dodge & Cox Stock fund, "if you can get into it."

Roy Ballantine, money manager at Ballantine Finn in New Hampshire, employs an entirely different tack for his customers' large-cap needs. Ballantine doesn't split large-cap stocks into value, growth and core, nor does he buy individual stocks or even funds. Instead, he keeps things simple by purchasing the

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ETF, which holds both value and growth stocks.

"I prefer to avoid the tax consequences that come with excessive portfolio rebalancing," says Ballantine. "If you break it up into too many pieces, there is a greater chance you will have to sell off a piece when you rebalance, thus causing a taxable event."

Stiles is also using ETFs to manage the large-cap portion of her clients' portfolios. She expects the practice to increase in the future due to its cost-effectiveness. Large-cap ETFs tend to have costs less than 0.25%, which is far below the 1.5% fee for the average actively managed mutual fund.

"As the industry evolves from mutual funds, we will use more and more ETFs," says Stiles. "They are a cheap, efficient alternative to traditional funds."