Large-cap growth funds outpace others in third quarter

Size did matter in the third quarter.

Returns from large-capitalization growth funds far outpaced those of other diversified equity funds in the July-September period as investors sought the safety and growth potential of big companies following the return of volatility and the stock market's pullback from its mid-July highs.

While the quarter ended near its highs, weeks of uncertainty over the health of mortgages made to borrowers with poor credit and the effects of a struggling housing market took their toll on mutual funds.

The 8,179 U.S. diversified stock funds tracked by Lipper showed an average preliminary return of 1.3% for the three months ended Thursday. That compares with 6.3% on the same basis for the second quarter.

Large-cap growth funds, meanwhile, showed an average return of 6.4%, according to preliminary figures from mutual-fund tracker Lipper.

Investors in funds that own big companies fared better during the quarter. Such companies can have an easier time securing financing during periods of tightness in credit markets — as has occurred in recent months. They also can generate earnings off of thinner profit margins and reap profits from overseas operations where economic growth is generally stronger than in the United States.

"Credit conditions favored large caps over small caps. The good value names out there have been bid up and the bad value names are probably unlikely to secure credit the way they have in recent years, so growth oriented companies with some decent cash flow also stand to benefit," said Lipper analyst Jeff Tjornehoj.

Even funds that invest in mid-cap issues performed better on average than funds that focus on smaller companies. Mid-cap growth funds posted an average return of 4.4%, while small-cap growth funds turned in 1.9%.

By comparison, the Standard & Poors 500 index rose 1.6% during the third quarter compared with an increase of 5.8% in the second quarter. The Dow Jones industrial average, made up of 30 blue chip stocks, advanced 3.6% compared with a rise of 8.5% in the second quarter.

During the quarter, the last trading day of which occurred Friday, investors showed a preference for technology companies — thinking perhaps such names might be spared somewhat amid a slowing economy. Science and technology funds showed an average return of 6.7%, while telecommunications funds returned 4.3%.

Financial services funds, meanwhile, had a negative return of 3.7% as Wall Street at times grew uneasy about whether subprime mortgages would sour and whether tightness in the credit markets would reduce profits at investment banks.

Among world equity funds, rising gold prices helped gold funds show big returns. Gold oriented funds posted an average return of 16.6% during the quarter, Lipper data show. And robust growth in China again produced outsize returns among funds focused there. China region funds showed an average return of 28.0% for the quarter.

With the market's back-and-forth movements, funds designed to keep returns steady in changing market conditions didn't perform as well as might have been expected.

Equity market neutral funds slipped 0.23%, while long/short equity funds lost 0.4%. Long/short funds employ strategies to bet certain stocks will rise while others will fall.

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