If investors have learned anything from the technology bubble, it's that they should be leery of any mutual fund category or sector that outperforms the stock market for any length of time.
Yet, although small-cap value funds have been hot for nine months, advisers think it's too soon to abandon them.
With the exception of September, when specialty real estate funds were tops, small-cap value mutual funds outperformed all equity fund categories since January, according to Morningstar Inc., Chicago.
But many financial advisers say a lot of juice still remains in the sector, although they warn that investing now in a small-value fund means probably missing a good portion of the runup.
The average small-cap value mutual fund was up 8.88% year-to-date as of Nov. 14, according to Morningstar, while the broad market was down 12.63%.
Advisers also say investors need to be pickier. It's probably a good idea to stay away from funds that are at the top of the category, they said.
Lou Stanasolovich, president of Legend Financial Advisors Inc., Pittsburgh, said a fund with performance that blows away its peers might be a risky bet for investors because the companies in which it invests might already have "blown their performance."
But that doesn't mean the category as a whole is finished, he said.
The universe of small-cap companies is much larger, Mr. Stanasolovich said. Morningstar identifies 5,400 small-, 896 mid- and 461 large-cap companies. While one set of small-cap value funds might fall out of favor, another set that invests in a completely different group of companies might take its place.
Of course those funds that are turning in stellar performances think they can continue to do well - and some observers think they just might be able to do it.
A good example is the $270 million Franklin Micro-Cap Value Fund, offered by Franklin Advisory Services LLC in Fort Lee, N.J.
It has been at or near the top of its small-cap value category for months. Year-to-date as of Nov. 14, it was up 33.97%, placing it first among all small-cap value funds, according to Morningstar.
Bruce Baughman, who manages the fund for the unit of San Mateo, Calif.-based Franklin Resources Inc., said it's not his intent to generate such heady returns, just respectable ones. Mr. Baughman said the fund stuck to its deep-value strategy even when that was out of style.
The fund is heavily invested in the industrial, financial and service sectors, according to Morningstar. Top holdings include Vesta Insurance Group Inc., a Birmingham, Ala., holding company for a group of insurance and financial services companies; and GA Financial Inc., a community bank in Whitehall, Pa.
Based on the tenure of the Franklin fund's managers and its relatively low expenses, said Michael Ryan, an adviser with the Professional Planning Group in Westerly, R.I., it might not be a bad one to "nibble at."
On the other hand, he suggests investors might not want to invest heavily in the fund. "While it is a diversified fund, there is a concentration of sectors that have done well," Mr. Ryan said. "There's probably other stuff that has been beaten down that will eventually do better."
Mr. Ryan likes the $841 million American Century Small Cap Value Fund. It was up 21.02% year-to-date as of Nov. 14, placing it in the third percentile of its small-value category, according to Morningstar. The companies in which it invests tend to have a bigger market capitalization than the Franklin fund, and its style is more blend than value.
Sam Hull, an adviser with Northstar Financial Planning Inc. in Bedford, N.H., agrees there are still good small-cap value funds. Among them are the $168 million Royce Micro-Cap Fund (up 12.27% year-to-date), the $248 million Third Avenue Small-Cap Value Fund (up 9.42%) and the $451 million Wasatch Small Cap Value Fund (up 22.84%).
Mr. Hull, however, said there is some evidence that at least some small-cap value funds are becoming too expensive, a sure sign the category might be about ready to turn.
Many of the top-performing funds in the small-cap value category are trading at 20 or more times their price-earnings ratios, suggesting some of them are starting to become too rich, he said.