Amid a falling dollar and a cloudy investment environment, domestic equity funds will return modest gains between two and 10%, according to Lipper.

Don Cassidy, senior research analyst at Lipper, expects rising interest rates to put competitive pressure on equities, as corporate earnings grow at a slower pace. Financial services funds, in particular, are likely to be affected by rate increases.

Given that small-cap stocks dominated much of 2004, Cassidy sees a potential comeback for large-cap stocks this year. He warns, however, that rate increases could dampen growth in large-caps.

Cassidy also predicts that value stocks, which have enjoyed a good run for the last four years, will continue to outperform growth stocks in 2005 as investors remain cautious about taking risks and look forward to greater dividend income.

The sliding dollar should make investors look outside the United States as rapid growth in emerging market economies like India and China fuels demand for international equity funds, Cassidy says.

Among the potential winners this year are natural resources funds, where growth will be driven by strong demand from the Chinese manufacturing sector. Utility funds, on the heels of a number of mergers in the industry, should also fare well. Cassidy expects technology portfolios, which lagged behind last year, to make a moderate rebound this year. Real estate funds, which have flourished for the last two years, are likely to see continued growth because of high yields and strong demand. Health and biotech funds might suffer as cost-cutting and drug recalls restrain performance at pharmaceutical companies.

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