Dear Dagen: Hunting the Undiscovered Small-Cap
How do I find a good small-cap fund?
Small-cap funds are a lot like neighborhood restaurants. Once they're discovered, they become too crowded and lose their appeal.
Finding a fund that hasn't been overrun by investors is just one of the challenges when picking a small-cap fund. Of course, there are the usual considerations: expenses, manager experience and diversification. But here are some suggestions to keep in mind when you're hunting for a small-cap investment, and some funds to consider.
Size KillsFirst and foremost, you want to find a small-cap fund that hasn't grown too big. In the world of small-cap investing, size can be a performance killer. Smaller companies offer a limited number of shares to the trading public. A manager of a small-cap fund that has taken in too much money can't put enough cash in any one stock to make a big difference in the fund's performance. And buying too many shares in any one illiquid stock can create wild swings in that stock's price that could actually hurt the fund's performance. As a fund grows larger, the manager could be forced to buy not only more stocks, but also stocks of larger companies. Before you know it, a hot small-cap fund riding 50 stocks can turn into a sluggish mid-cap fund sitting on 200. The Kaufmann fund -- now the
Commitment to ClosingMoreover, you want to find a fund that has promised to close when its assets reach a certain level, or shown a willingness to close in the past. The giant $13.5 billion (FLPSX)Fidelity Low-Priced Stock fund has closed three times in the past and will surely close again if the inflow of money is too much for manager Joel Tillinghast to handle. (Despite its size, this fund continues to produce outstanding returns, proving that there are exceptions to every rule.) And the managers at Wasatch have been diligent about closing their successful funds. Of the six stock funds in the Wasatch family, only two are open to new investors. The managers of the superb (BUFSX)Buffalo Small Cap fund have said they would consider closing the fund when its assets hit $1 billion. And thanks to its 31.2% return last year, the fund has already passed that mark. For now, Buffalo Small Cap is still open to new investors, but you must buy shares of it directly from the fund company. That raises another problem: You want a fund that's willing to close before it gets too big and changes character. But when it does, you're probably locked out unless the performance heads south and it's forced to reopen. Last year, small-cap value funds were the place to invest. The average fund in that category was up 17.2% in 2001. And that impressive performance in an otherwise dismal year has attracted a lot of new money. Frankly, it's hard to find a good small-cap fund that's still open to new investors. The (ARTVX)Artisan Small Cap Value fund is closed. So is the
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