Investors in small-cap funds may be in for a big surprise. Many portfolio managers hold heavyweight stocks like Verizon Communications, Boeing and Pfizer in funds that claim to focus almost exclusively on shares of small-capitalization companies.
Overall, 211 out of the 476 actively managed small-cap funds tracked by Lipper own companies with market capitalizations of $10 billion or more. That is more than twice the size of companies that Lipper defines as the focus of small-cap funds.
Investors in these actively managed funds - which include those from such well-known firms as Gabelli, Charles Schwab and T. Rowe Price have several reasons to worry, fund experts and financial advisers say.
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First, small companies typically outperform over time, because they have greater growth prospects than established large-cap companies whose days of rapid expansion are behind them. That said, large caps may offer dividends and hold up better during downturns.
Between 1927 and 2012, for instance, small-cap stocks produced average annual returns of 12.9 percent, compared with a 9.9 percent gain for large companies, according to data from Vanguard. This year, the Russell 2000 index has gained 24 percent since the start of January, compared with a 19.7 percent gain for the large-cap Standard and Poor's 500.
Every dollar in a small-cap fund invested in a mature company like Pfizer -with a market cap of $206 billion - is not going toward what could be its more upwardly mobile competitor.
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And second, the presence of big companies in small-cap funds can skew an investor's overall asset allocation, effectively giving extra exposure to large companies. That can increase overall risk by giving investors less diversification than they may think they have.
"This is something I absolutely worry about," said Richard Weeks, a managing director at HighTower Advisors in Vienna, Virginia who oversees $800 million in client assets, and carefully balances the assets in his portfolios. "The only way I can try to have a risk managed portfolio is to construct a diversified group of different assets."