He continues: "In volatile times like we've had over the past couple of months, I would expect large caps to outperform small caps, but it's too early to conclude that small caps have lost their market leadership. It could be that we're late in the cycle, but if the credit situation gets clarified, I wouldn't be surprised to see small outperform large."
Echoing O'Halloran, Daniel Perkins, who is part of a father-son team managing the $42 million Perkins Discovery Fund, a microcap vehicle, says, "It's still not clear if large-cap stocks are moving into the lead. The small-cap leadership has gone on for eight years, which is quite a while, but they have led for longer periods in the past. The trend hasn't clearly changed yet."
Likewise, Steven T. Merkel, CFP, ChFC, and vice president of portfolio management at Financial Advisory Consultants in Naples, Fla., says, "The spin is that small caps are more risky than large caps. But over time, small caps are more rewarding than what you would get from a large-cap investment."
Royce & Associates, a firm that deals exclusively with small caps and has $32 billion under management, is a good proxy for the value investing style in the small-cap world. Even its growth funds are more value oriented than the average small-cap growth fund. Five-year-old Royce Value Plus Service, with $2.75 billion in assets, for example, has been a top fund in Morningstar's small-cap universe for the past three years.
"We've done better than the Russell 2000 index in this fund in all four down markets except one since 2004," says the fund's manager, James A. "Chip" Skinner III. "Our main focus is to preserve capital. We get a kick out of outperforming when times are tough."
Though he buys primarily as a value manager, Skinner is not afraid to buy a growth company as long as it has a good balance sheet and he doesn't have to overpay for it. In that vein, he's been adding technology stocks to the fund's portfolio as he's noticed IT spending in that sector has increased. He also has started bulking up on precious metals stocks. With the increase in precious metal prices, "Gold and silver have taken on a more serious investment status," he notes.
Two other Royce managers, Whitney George and David Nadel, co-heads of Royce Global Select Fund, see the market's turbulence as part of the normal rotation cycle between small-cap and large-cap companies, and view it as a buying opportunity. "It's an evergreen universe, and particularly when people feel more confident about their investing they tend to gravitate towards it," says George, a 16-year veteran with Royce. "We look at the world on a three- to five-year basis, and we would view those kinds of corrections as good times to buy smaller companies because, over the longer term, given our approach, they have done better."
Royce Global Selection was launched slightly more than two years ago. The preponderance of its portfolio is in U.S.-based stocks with a significant foreign exposure. With an investment minimum of $50,000, the fund is tailored to advisors and high-net-worth investors. It has a hedge-fund-like performance fee. The fee is 12.5% of its high watermark performance, meaning in a flat or down market, the fund bears the expenses and charges no management fees.
Instead, Royce absorbs it, says Nadel. Both he and George are investors in the fund. "We eat our own lunch," says Nadel.
As for his outlook on the international sector, Nadel says good buys exist in such markets as the United Kingdom, Brazil, South Africa, Finland and Japan. Meanwhile, in his opinion, "Systemic risks of the past in international investing, be they fluctuations in currencies, inflation or interest rates, have been structurally reduced."