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(This version of the story replaces "The shares" with "Small-company shares" in second to last paragraph)
By David Randall
NEW YORK (Reuters) - As the S&P 500 index of large companies flirts with a record high, many U.S. fund managers are opting to go small instead, betting that small caps have more potential for appreciation.
Multi-cap funds - those run by fund managers who have the freedom to hold companies of any size - have nearly 20 percent of their portfolios in small-cap stocks now, the largest allocation over the last three years and a 6.5 percentage point jump from this time last year, according to Lipper data.
Fund managers say that they are attracted to smaller companies in large part because the Russell 2000, an index of small-company stocks, remains 12 percent below its record high of June 2015, suggesting that smaller stocks still are recovering from the steep declines brought about by plunging oil prices and concerns about the Chinese economy.
With retail sales and the job market improving in the United States, shares of smaller companies - which tend to get most of their revenue domestically - could have more room to run.
"We're seeing a lot of reach for quality and stability in the marketplace, with things like consumer staples and utilities trading at some of the largest premiums to the market that we've ever seen. On the other side of that trade is that small caps are being left for dead," said Connor Browne, portfolio manager of the $910 million Thornburg Value fund.
Browne, who has nearly doubled his holdings of small caps stocks to 36 percent of his portfolio over the last three years, said that he has been adding smaller companies such as for-profit education company Grand Canyon Education Inc and Phibro Animal Health Corp, which get nearly all of their revenues domestically.
The Russell 2000 is up slightly less than 1 percent for the year to date, compared with a 1.4 percent gain for the S&P 500. Yet it trades 9.3 percent below its level this time last year. The S&P 500, meanwhile, is down just 1 percent over that time.
Some of the interest in small companies now is a reflection of a bounceback in U.S. crude oil prices, which touched 13-year lows of $26.21 a barrel in February and eviscerated small energy producers. Oil rebounded over the spring, trading at $49.70 at midday Tuesday.
Scott Goginsky, a portfolio manager at the $20.4 million Biondo Focus fund, said he more than tripled his allocation to energy stocks in the first half of the year, buying oil production companies such as Diamondback Energy Inc and Sanchez Energy Corp.
"It was clear that as long as these companies didn't go out of business, you would eventually make a ton of money because they were just so cheap," he said.
Goginsky is still adding to his positions in the sector because he expects there to be "considerably larger" increases in the year ahead as the price of oil stabilizes and draws more investors back in.
Sandy Villere, portfolio manager of the $417 million Villere Balanced fund, said that small companies also stand to benefit should the Federal Reserve raise interest rates again this year. That would likely strengthen the dollar, cutting into the profits of multinational companies that generate more of their revenue overseas.
Villere has been buying shares of companies such as Taser International Inc, which outfits police departments with body cameras, in addition to making electroshock weapons. Small-company shares represent 85 percent of Villere's assets, the maximum allocation to small-caps allowed by the fund's prospectus.
"We have as little cash as we've ever had," he said.
Reporting by David Randall; Editing by Linda Stern and Steve Orlofsky