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Small-cap primer

Mark Jewell, the personal finance for the Associated Press, takes note of a milestone that didn't get much attention amid last week's other important news: The Russell 2000 index of small cap stocks hit an all-time high.

[The Russell index is] up nearly 143 percent from its low in March 2009, when stocks hit bottom during the financial meltdown. By comparison the Standard & Poor's 500 is up 99 percent....

Here are answers to common questions about the Russell 2000, why it's climbed so high, and whether the small-cap surge still has momentum:

Q: What stocks are in the Russell 2000?

A: The Russell 2000 includes 2,000 of the smallest stocks, based on their market capitalization. Small-cap stocks are typically defined as companies with a market value of $300 million to $2 billion....

That value of the Russell 2000 represents 8 percent of the total stock market. By comparison, the S&P 500 represents about 75 percent, which is why those stocks anchor 401(k) and other retirement accounts....

Q: Why has the Russell 2000 climbed so high?

A: Small-cap stocks tend to be among the first to rise when the economy rebounds. That's because these companies are more nimble operationally, and generally invest in their growth as a recovery gains momentum.... Small-cap stocks have also benefited from low interest rates. Smaller companies are more likely to rely on borrowing, and low rates can really help a bottom line.

Q: How long have small-cap stocks been outperforming large-cap stocks?

A: Small-cap stocks have outperformed large-caps for most of the last 11 years. Their current dominance outlasts a 9-year small-cap run that started in 1974....

Q: Can small-caps keep this up?

A: Many market pros say the small-cap advantage is about to end. They argue small-cap stocks have risen so high that they're unjustifiably expensive, considering the profits they're expected to generate....

Q: Why might the small-cap rally still have legs?

A: Small-caps could increasingly become buyout targets of bigger companies looking to dip into cash hoards that have grown to record levels. S&P 500 companies have $940 billion on hand, with nearly one-third of that stash accumulated since late 2008. Expect stocks of acquisition targets to surge when deals happen.

Meanwhile, Morningstar reports that several well-known small-cap funds have closed (or are closing) to new investors. (Funds typically close because more money is coming in than the manager thinks he or she can invest wisely.)

American Beacon Small Cap Value and Heartland Value Plus will soon close to new investors.

Their closures follow the shuttering of a number of other small-cap funds in recent weeks and coincide with more than two years of strong performance and rising valuation levels for the Russell 2000 Index and other small-cap benchmarks....

Royce Micro-Cap and Royce Premier also said they will remain open only to existing investors and certain preapproved relationships.

SMI's investing strategies help you stay broadly diversified across the market, so you can gain from strongly performing categories (such as the current performance in small caps) without taking the high level of risk that comes from being overly concentrated in any one area.

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