SMALL-COMPANY STOCKS

suffer when the greenback declines. A big reason: Smaller businesses are usually domestic in nature, relying on dollar-denominated sales rather than overseas sales that are payable in more lucrative currencies. Or at least that's how the traditional thinking goes.

But today, more small companies are reaping rewards from global growth, thanks in large part to a world of commerce made increasingly interconnected by advances in technology. It's these internationally minded small caps that are now in favor among small-cap investors against the backdrop of a weaker dollar.

"The conventional wisdom is that an environment of a falling dollar is not good for small-cap stocks," says Nancy Prial, portfolio manager of Managers AMG Essex Small/Micro Cap Growth funds and , part of Managers Investment Group. "What has changed is the nature of these smaller companies and the nature of the small-cap market itself. There are many small companies now that have significant amounts of business being driven from overseas. That wasn't true 20 years ago."

The Federal Reserve's decision last month to cut its target on the rate banks charge each other for overnight loans sparked a quick selloff in the already anemic greenback. Recently, the euro, Canadian, Australian and Singapore currencies have all hit fresh highs against the U.S. dollar. While a weaker dollar can help some U.S. exporters, smaller companies have historically underperformed larger ones when the dollar is down.

According to Ned Davis Research, small-cap stocks have performed better on an absolute basis when the dollar is weaker, likely due to the effect of lower interest rates. But compared to large caps, small-cap stocks have lagged when the greenback is falling. The small-cap benchmark Russell 2000 index has gained about 12% a year amid a weak dollar, compared to the large-cap Russell 1000, which has gained about 14% a year.

But times are changing, and with that change comes the need to take a fresh look at entrenched beliefs about small caps. Neil Wagner, portfolio manager of Small Cap Growth Equity Portfolio and Small Cap Growth II at investment firm BlackRock, says "small caps are so diverse today that no matter where we are in the economic cycle there are opportunities."

Tom O'Halloran, director of small-cap growth investments at money management firm Lord Abbett, chalks up the shift to rapid technological innovations in recent years: "Small-caps have more international exposure today than in the past. Because of the Internet [and] plunging computing and communications costs, smaller companies can reach international markets more easily."

Small-cap funds, not surprisingly, also have more international exposure. Over the past five years, the average percentage of assets that U.S. small-cap funds invest in foreign companies has grown to 4.06% from 2.63%, according to Morningstar.

But it's hard to measure the full extent of small-cap funds' international exposure, because in addition to tracking companies earning revenue from overseas, there are companies that are suppliers to larger companies earning revenue overseas.

"We get questions from investors about how much international exposure we have, but it's a difficult thing to say because it's constantly increasing with the world so globalized now," says Brett Hawkins, portfolio manager of Old Mutual TS&W Mid-Cap Value I Fund, which is a part of Old Mutual Asset Management.

Tony Sutton, portfolio manager of Putnam Small Cap Growth fund, says the key is finding companies with good fundamentals and international exposure as a "side plus."

Koppers Holdings, a maker of materials used to manufacture aluminum and steel, is one example. Roughly 40% of its revenue came from outside of the U.S. last year, and the company recently launched a new joint venture in China. "It's a great company with a nice niche and the international exposure gives it a nice push to the upside," Sutton says.

Another example is Dollar Financial, a small check-cashing and short-term-loan company. Three years ago, it generated nearly half of its revenue from American consumers. Today, that amount has fallen to less than a third and Dollar Financial is making the bulk of its profits from Canadians and Brits. "The best way to remain in business is to be diversified diversified in geography, products and platform," says Dollar Financial Chief Executive Jeffrey Weiss. "We intend to grow the U.S. business aggressively, but we intend to grow internationally more aggressively."

Tucker Walsh, chief executive of Copper Rock Capital Partners, says it's particularly important for small-cap companies to have a broad distribution for their products, making an international footprint key. Walsh says the firm is interested in several small caps that are suppliers to larger corporations with international business. Ladish, for instance, makes jet engine and missile parts, helicopter rotors and other aerospace products. Last year, U.S. exports accounted for about 51% of Ladish's net sales. Its top customers include Rolls-Royce, United Technologies and General Electric.

This weak-dollar trade isn't likely to go away soon. Market watchers generally expect the U.S. currency to remain volatile, if not weaker, in the near term. Citigroup economist Gabriel de Kock, in a research note on Sept. 28, said he expects subpar U.S. economic growth to hold the dollar down into next year, while the country's ability to attract foreign capital is "dimming."

Roger Edgley, director of international research at Wasatch Funds and manager of Wasatch Emerging Markets Small Cap fund, says "the U.S. is not completely friendly to global capital," noting last year's controversy when state-owned Dubai Ports World tried to buy container terminals at U.S. ports.

But if U.S. businesses are going to grow, big or small, they'll have to think globally.

"The theme is really, how tied into global growth is a small company?" Edgley says. "When you are a U.S. fund manager sitting in the U.S., you can't see growth. When you go to China, India, the Middle East, you can see growth. You see cranes, construction; it's visible. The question for small caps is, can you take advantage of this global growth and a cheap dollar?"