Small companies were hot performers in the stock market during the third quarter, and that was good news for several mutual funds offered by banks.

Small-company funds took two of the top five spots in American Banker's quarterly ranking of mutual funds operated or sold exclusively by banks.

Both of the funds, which invest in companies with market capitalization of $1 billion or less, are offered by units of Michigan banks.

Comerica's Ambassador Small Company fund took top honors, with a third-quarter total return of 9.75%, while First of America's Parkstone Small Capitalization Value fund nabbed fourth place, with a return of 8.2%.

Average Return: 3.2%

The average return for the 225 funds tracked by the survey - a number that excludes money market funds - was 3.2%, according to CDA/Wiesenberger, which compiled the performance data.

Investment managers said the strong showing by small-cap funds during the July-to-September quarter reflected rising investor confidence in the earnings potential of smaller businesses.

"We've benefited from the return to favor of growth stocks," said George Eshelman, president of Comerica's Woodbridge Capital Management unit.

The quarter helped Mr. Eshelman reverse what had been a dismal showing for growth stocks earlier in the year. His small-growth fund has eked out a return of 3.3% for the first nine months of the year, compared with 3.8% for all bank-affiliated funds tracked in the survey.

Premier Fund Places Second

Second-place honors for the third quarter went to Premier Bancorp's Paragon Gulf South fund, a long-term growth fund that is heavily weighted to small-company stocks, according to Donald E. Allred, president and chief investment officer of Premier Investment Advisors.

Rounding out the top five were Bankers Trust Co.'s Huntington Hard Currency fund, which ranked third, and Comerica's Ambassador Growth Stock fund, which placed fifth.

For the year to date, the three international bond funds - all offered by Bankers Trust Co. - have been the most impressive performers, producing an average return of 8.27%. As a group, they placed third in the third quarter, with an average of 4.41 %.

A Rare Offering

Small-cap funds are a rare commodity in the banking industry, reflecting bank customers' aversion to risk. In addition to the Comerica and First of America offerings, only two other banks in the survey - Philadelphia-based Glenmede Trust Co. and Cincinnati-based Star Bank - have them as part of their fund menu.

In contrast, 172 of the 225 bank-run mutual funds are concentrated in five investment-objective categories: long-term growth stocks, corporate bonds, taxable U.S. government bonds, tax-free single-state municipal bonds, and growth and current income.

Comerica's Mr. Eshelman attributes his strong first- and fifth-place performance today to steering a steady course as the market fell earlier in the year.

"A lot of the kinds of stocks we like to buy became inexpensive, and we accumulated positions that paid off handsomely in the third quarter," he said.

Slot Machines to Wheelchairs

Mr. Eshelman focuses on firms with market capitalizations of $400 million to $500 million in his top-performing small-company fund. Among his best stocks last quarter were International Game Technology, which makes slot machines, and Sunrise Medical, which make wheelchairs and specialty mattresses. Both were up about 50% in the quarter.

"We focus on companies, not industries, and we look for attributes like quality and accelerating earnings," said Mr. Eshelman, who refers to himself as a "bottom-up investor."

Proprietary Funds

In his fifth-ranked Growth Stock fund, he said he looks for "bigger companies that really seem to have the wind at their back in respect to current and future earnings." Big winners last quarter were U.S. Healthcare, Circus Circus Enterprises, and automotive supplier Leggett & Platt, he said.

In Louisiana, Premier Bancorp is not only the proud sponsor of the second-best performing fund but also ranks as the sixth-largest provider of proprietary bank mutual funds in the country.

The Baton Rouge-based company was one of the first banks in the country to convert all of its commingled and common trust fund assets to mutual funds in Dec. 1989. The strategy is paying off in booming sales and improving performance, said Mr. Allred.

He pointed to his Paragon Gulf South Fund, which took second place by returning 8.85% in the third quarter.

"That little fund was $7 million in June of 1991. It's $47 million now, so it's catching the retail attention," Mr. Allred said.

Though the fund suffered big losses on health care stocks during the first half, Mr. Allred thinks its investors are in for some long-term rewards.

A Regional Slant

"We think the stage is set now to have four to five years of small companies outperforming the large-capitalization firms," the fund manager said.

The Gulf South Fund specializes in regional growth companies, with consumer stocks making up at least half of the portfolio.

"I like names that tell me what the business is all about," Mr. Allred said. "Home Depot, for instance - we bought a lot of that back in 84. It's gone up so much over the years that our biggest problem is that we have to keep selling."

Among his other homey-sounding favorites, he said, are Office Depot and Cracker Barrel Old Country Store Inc.

At First of America, the largest bank provider of homegrown mutual funds, the Parkstone Small Capitalization Value Fund took fourth prize, returning 8.20%.

But year to date it has lost 9.33%. Its three-year performance record is 8.18%, one percentage point below the average three-year total return for all bank funds.

The fund, which has $207 million in assets, has traditionally been marketed to trust clients, but that is changing.

"Retail sales have come on very strong the last year," said Richard A. Wolf, president of First of America Investment Corp.

First of America, meanwhile, said that its entire Parkstone family of eight funds is proving increasingly attractive to customers.

"Our bank was very early into it, and saw the potential in it," Mr. Wolf boasted.


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