Saturday Screen: Micro-Cap Funds You Can Still Get Into

Micro-cap stocks combine big risks, big potential returns and, sometimes, attractive prices. Break out your magnifying glass, because today we're looking at funds that feast on them.

No, micro-caps aren't tiny hats. They're small and often young companies with market capitalizations of $325 million or less, at least according to Morningstar's definition. Over the long term, studies show they've posted higher returns than large-cap stocks, but their fledgling nature makes them much more risky.

Micro-caps look a bit less risky than they used to, though. The market's obsession with large-cap growth stocks, and tech stocks in particular, in recent years, has left many small- and micro-cap stocks with attractive valuations. That has some managers licking their chops.

"It's a fertile hunting ground right now for under-followed and undervalued companies that are growing quickly," says Rainerio Reyes, co-manager of the $117.6 million (RSMGX Quote)RS MicroCap Growth fund, which has returned 44.9% over the past year.

"It's a good time to look at these because micro-caps, particularly on the value side, aren't trendy right now," says Russ Kinnel, director of fund analysis at Morningstar. And if you're going to jump into the micro-cap pool, a fund is probably the best route, he says, since many of these companies are obscure and thinly traded.

So this week's Saturday Screen sifts for domestic funds that invest in micro-cap stocks. To make our list, funds had to beat the average small-cap fund over the past three years, have a manager who's held the reins for at least that long and have a median market cap of $325 million or less. They also had to be open to new investors -- no small concern, since micro-cap funds tend to close quickly. A big asset base can make it tough to buy thinly traded stocks without moving their prices and paring returns.

Here's our top 10:

Funds That Think Small Top-performing micro-cap funds.
Fund	YTD Return	Median Market Cap. ($mil.)	Avg. P/E Ratio
(BMCFX Quote)Bjurman Micro-Cap Growth	12.7%	$244	38.3
(WMICX Quote)Wasatch Micro Cap	6.7	260	26.9
(RYOTX Quote)Royce Micro-Cap	4.7	176	20
(PRSVX Quote)T. Rowe Price Small-Cap Value	3	270	18
(TCSVX Quote)Clover Small Cap Value	1	247	25.6
(HRVIX Quote)Heartland Value Plus	-0.1	156	18.4
(DFSVX Quote)DFA U.S. 6-10 Value	-1.2	303	21.8
(DFSCX Quote)DFA U.S. 9-10 Small Company	-4.2	160	23.8
(RHJSX Quote)UAM Rice Hall James Small Cap	-7	229	25.5
(HRTVX Quote)Heartland Value	-9.3	205	15.9
Small-Cap Funds Avg.	-0.3	1,300	34
S&P 500	-1.8	89,725	37.1
Source: Morningstar. Performance figures through May 30. Portfolio data through most recent public portfolio and may have changed.

If many of these names sound unfamiliar, it may be because some of the best-known micro-cap funds are currently closed, including the $134 million (TMCGX Quote)Turner Micro-Cap Growth, the $225 million(VWMCX Quote)Van Wagoner Micro-Cap Growth and the $841 million(FUSMX Quote)Fremont U.S. Micro-Cap funds.

Still, we've turned up some intriguing candidates.

"Looking at this group, (WMICX Quote)Wasatch Micro Cap, (RYOTX Quote)Royce Micro-Cap and (PRSVX Quote)T. Rowe Price Small-Cap Value are the most appealing," says Morningstar's Kinnel.

The funds are among the category's graybeards. The Royce, T. Rowe Price and Wasatch funds started in 1991, 1993 and 1995, respectively. All favor value stocks, which means they tend to hold companies that are undervalued, either by traditional yardsticks like price-to-earnings or price-to-book ratios or in light of anticipated growth. That value bent has kept volatility under control for these funds, but hasn't kept them from beating the average return in their category.

Wasatch's Robert Gardiner has run the $186 million fund since its inception, seeking solid growth stories selling at attractive prices. The no-load fund's heaviest sector weightings were in retail and health care stocks at the end of April, according to Morningstar. The fund's 28.5% annualized return over the past three years beats the S&P 500 by more than eight percentage points and its average peer. Its 2.46% annual expense ratio, however, is well above the 1.7% charged by its average peer.

Charles Royce has held the reins of his eponymous fund since its inception; W. Whitney George joined him in 1993. The $123 million fund takes a diversified approach, holding more than 140 stocks. The no-load fund's 13.2% annualized return over the past five years beats its average peer, and its 1.49% expenses are below average.

Some would say the $1.2 billion T. Rowe Price fund isn't a pure micro-cap, but most micro-cap funds own at least some larger stocks. At the end of April, 57% of the fund's assets were invested in micro-caps, with the rest invested in small-caps, according to Morningstar. Manager Preston Athey's diversified value style has paid off since he took over in 1991. Over the past 10 years, the fund has averaged a 13.4% annual gain, which beats its average peer. While its big asset base might be a concern, it also makes its modest 0.87% expense ratio possible.

If you're more interested in a high-octane approach, look at the little-known fund at the top of our list, the $23 million (BMCFX Quote)Bjurman Micro-Cap Growth. Manager O. Thomas Barry, who's run the no-load fund since its 1997 inception, isn't shy about betting on sectors he likes. At the end of the first quarter, the fund had half its assets in tech stocks, and its tech stake has been as high as 70%. That aggressive approach has paid off, though. The fund's 38.5% three-year annualized return beats 93% of peers' and dusts the S&P 500 by more than 18 percentage points. The fund's 1.8% expense ratio is only slightly above average.

The fact that the fund weathered this year's volatility, despite its big tech weighting, shows that micro-caps often don't track with their large-cap peers.

"Micro-caps do give you greater diversification because they often act differently than the S&P 500. Even when small-caps head in one direction, micro-caps might go somewhere else," says Kinnel.

Another growth-oriented micro-cap fund is RS Micro Cap Growth. It didn't make our list because of its $404 million median market cap on April 30. Still, 50% of its assets were invested in micro-caps, according to Morningstar. The fund's high-growth approach -- its average price-to-earnings ratio is 43 -- has worked out. Its 26.4% annualized three-year return beats the S&P 500 by nearly six percentage points and bests more than 70% of its peers.

The two DFA funds on our list are sort of index funds. They divide the market into deciles, or tenths, and buy stocks in selected deciles. The $2.9 billion (DFSVX Quote)DFA 6-10 Value fund, for example, holds the smallest four deciles, or 40%, of the stock market. The $1.7 billion (DFSCX Quote)DFA 9-10 Small Company holds the smallest, 20%. Both funds' expenses are below 0.6%, and it's very difficult to buy shares in them except through selected financial advisers. (For more on DFA funds, see a previous Dear Dagen column.)

If you're looking for a small-cap fund that dabbles in micro-caps, you can probably rest easy. Most small-cap funds have at least some micro-cap exposure. So check out what's in the funds you've already got because they might have all the micro-cap exposure you need.