Mutual Funds

Return to Article

Daily Screen: The Best Small-Cap Growth Funds

Ian McDonald

Ah, the feast-or-famine world of small-cap investing.

Today the Daily Screen checks out the small-cap growth fund category, which is showing investors its fickle personality. Some of last year's highest fliers were tech-heavy small-cap growth funds, which posted a 62% return on average, according to Morningstar. But this year they're up just 0.9% on average, illustrating the tired-but-true tenet that small-cap investing requires patience and a strong stomach.

So, what do we mean by small-cap growth, anyway? These funds invest primarily in small-capitalization stocks, typically defined as those with a market capitalization of $1.5 billion or less. Growth stocks are typically those of fast-growing companies, often in hot sectors like technology or biotechnology, that sell at high valuations relative to the overall market.

As usual, we've screened the small-cap growth pack for funds that beat their average peer over the past one- and three-year periods. The first table lists the top 10 funds ranked by one-year return. These 10 funds fit the small-cap growth profile, averaging a $1.5 billion median market capitalization, a 59% tech-stock weighting and a steep 44 average price-to-earnings ratio, compared with 26 for the S&P 500 , which is comprised mainly of large-cap stocks.

These high-octane funds sport some eye-popping returns, as they average a 101% gain over the past 12 months. The second table shows where those gains came from. It's a list of the cumulative top 10 holdings of the top 10 funds.

As you might imagine, the list is rife with tech stocks. What you might not have expected is the preponderance of large-cap stocks. Small-cap funds' top holdings are often big-cap stocks because they're winning picks that the manager has ridden for some time, occasionally taking profits and putting that money to work in smaller fare.

Although the style police might scoff at this practice, it makes sense as long as the fund is still invested mainly in small-caps. After all, selling favorite stocks just because they're thriving would be like planting a garden and yanking all the flowers out of the ground just because they grew too high.