Micro-cap Funds

Every investor dreams of getting in on the ground floor of small companies with the promise of extraordinary high growth. The new mutual funds that let you live that dream are "micro-cap" funds. They are called so because they're looking to invest in companies lurking far below most fund managers' radar screens. They're especially trying to find investments too small for the growing breed of "small-cap" funds who, despite their name, rarely invest in companies with market capitalization of less than $300 million.

Micro-caps invest in companies whose market capitalization (share price times number of outstanding shares) is $5 million to $75 million. These are lesser-known firms in their early stages of sales and profitability.

While these funds have the potential to produce sizzling returns, they might just as easily fail. Less liquid and more volatile than small-caps, micro-cap funds should be considered only for long-term investment. Investors who may need quick access to their cash should limit their investment to less than 10% of their portfolio.

What companies do micro-caps invest in? They look for companies with modest debt, a reasonable return on equity and proven management performance. They also share the risk by buying into firms where management holds a significant amount of stock. Micro-cap managers also look for companies in a favorable market niche, such as the digital economy and environmental technology sectors, and stay away from "concept stocks"-- firms with no earnings whose stock is rising mainly on the strength of investor enthusiasm.

Willing to try? The experts advise you to research each fund and its manager. Find an investment style that best fits your own appetite for risk, and don't judge your money manager too harshly if one year is bad.

By Nancy Larin, April/May 1998