DOW JONES INDUSTRIAL AVERAGE 10,000; WHY SUCH A BIG NUMBER MEANS SO LITTLE TO SO MANY.

Byline: Deborah Adamson Daily News Staff Writer

Ever wonder why your mutual fund or portfolio returns don't do as well as the Dow Jones industrial average?

It's a reasonable question, considering the mass media popularity of the Dow and its sister indexes, the Standard & Poor's 500 and the Nasdaq Composite Index. And when the Dow passed the 10,000 mark for the first time last month, pundits and financial pros marked the occasion by declaring that investors everywhere were doing fantastically.

So why aren't your investments doing as well?

There are a variety of scenarios, according to Wall Street pros, that have conspired against Main Street investors. For example, the fact that the Dow is a compilation of just 30 of the largest companies puts added weight on those companies' returns, and makes it harder to match those returns without exactly mirroring the Dow's complex mix.

In addition, the rise of Internet companies has warped the market and investors' returns. Those companies are taking money from investors that in years past might have gone to the small and midsize companies that fill out an investors' portfolio.

But of all the reasons why your portfolio isn't doing as well as the Dow or the S&P 500, investors' flight from small and midsize companies might be the most surprising. After all, it's an accepted investment wisdom that, over time, smaller companies will grow faster than large companies.

That's why most investors hold a variety of stocks, from blue chips such as General Electric to small companies such as St. Johns Knits or Cheesecake Factory. Small and mid-cap companies are generally defined as those that have a market value of $10 billion or less. That market capitalization, or market cap, is calculated by multiplying the company's share price by the number of its shares outstanding.

But in fact, shares of small and midsize companies have been in a slump for the past 18 months, and have had a spotty record since 1982. While they've had a better showing this month, the outlook for them is uncertain, analysts say.

One reason for the big-cap surge is the flow of money into mutual funds that buy the largest companies, according to Richard Earnest, fund manager for the billion-dollar Value Momentum Fund in Los Angeles.

``There's been an acceleration out of small and mid-caps into large-caps,'' he said. ``It has been an investor phenomenon.''

The money going into small-cap funds sank from $24 billion in 1997 to $3.7 billion last year, he said. In the first two months of 1999, small-cap funds actually experienced a withdrawal of $5.4 billion.

For mid-cap funds, the story is much the same: From an inflow of $11.2 billion in 1996, it dwindled to $2.1 billion in 1997 and declined by $2.6 billion in 1998. For January and February of this year, investors withdrew $1.5 billion.

In contrast, large-cap growth funds have sucked up plenty of cash.

In 1997, they attracted $51.8 billion; in 1998, $68.3 billion. For the first two months of 1999, they already drew in $25.5 billion.

Earnest, whose fund owns many small- and mid-cap stocks, said these markets started unraveling as far back as 1982 as large companies began to get lean and mean.

The big boys restructured, laid off employees, trimmed costs and began expanding overseas - all of which led to better earnings growth than smaller stocks, Earnest said.

As large stocks gained favor, investors have put their money there.

In fact, this has become a vicious cycle for small-cap investors: Large-caps attract money away from mid- to small-caps because of better performance. Massive withdrawals from mid- to small-cap funds force portfolio managers to sell stock so they can give investors back their money.

Such selling drives prices of mid- to small-caps even lower. Investors see that small-cap prices are falling, compared with the growth in large-caps, and start pulling their money out and putting them into big stocks.

The same cycle prevents many investors from even hearing about the smaller companies. With fewer institutional investors buying into small- and mid-cap stocks, the number of analysts following them has decreased too. With less coverage, there's a smaller likelihood that the investing public will hear about the small companies.

Investors' love affair with Internet stocks also has hurt small- and mid-caps.

Historically, the attraction of smaller stocks has been the greater possibility that their stock prices will go up faster. After all, the theory goes, smaller companies can grow faster because there's more market share to grab and they're better able to do it since they're nimbler and leaner. When companies get big, they tend to lose this flexibility.

But with Internet stocks, speculative investors get the fast growth of small stocks but in a large-cap setting. They're lured to the sector by the possibility of triple-digit growth, investing in large-cap companies like America Online and Amazon.com with money that might have gone to small-cap stocks in year's past.

(Ironically, while several Internet stocks might qualify as large-cap based on their market value, they're really small companies in terms of sales and employment.)

So what will it take to rejuvenate the small- and mid-cap market?

When investors get tired of high valuations and decide to troll for bargains among small stocks, analysts say.

A surge in acquisitions of small companies by large firms should bring investor attention back to the smaller end of the market as well, said David Hintz, senior research analyst for the Frank Russell Co. in Tacoma, Wash.

Earnest said he thinks it will take a major correction among blue chips to push investors away from the large-cap table.

Some think the market is starting to turn already. In the past two weeks, the Russell 2000 - which tracks 2,000 small-cap companies - has outperformed its large-cap sister, the Russell 1000, by 2 percent, said Hintz, whose company runs the Russell indexes.

``The pendulum will swing in the other direction,'' asserts George Shirk, associate editor of Mutual Funds magazine in Deerfield Beach, Fla.

CAPTION(S):

Chart

CHART: RETURNS

Although gains have been significant for large cap stocks such as the Dow Jones industrial average, returns for mid- and small-cap stocks have been disappointing

SOURCE: Frank Russell Company

Bradford Mar/Daily News