Five Funds: Small-Cap Value Offerings That Earn Your Money

Editor's note: This is the second installment of a weekly series, Five Funds, which offers solid mutual fund picks in a specific category. This week's focus: Small-cap value.

If you're looking for a solid small-cap value fund, that's easy. It's finding ones still open that can get tricky.

Small-cap value offerings -- which, as their name suggests, focus on companies with a market capitalization between $500 million and $1.5 billion that look undervalued -- declined 10.3% on average during 2002. In the abysmal 2002 year just passed, that was enough to rank small-cap value funds as the best-performing equity mutual-fund category, according to Lipper -- excluding short funds, natch.

Their relative success in 2002, coming after outperformance in 2000 and 2001, led many investors to pour money into the fund category. Since small-cap funds often close once they reach about $1 billion or so in assets (a rule of thumb, not written in stone), more than 40 small-cap funds shut their doors to new investment money in 2002, according to Morningstar.

As we hunt for the best small-cap value funds in fundland for this week's Five Funds, the bad news is that several top-shelf ones are closed to new investment. Among them are (PRSVX Quote)T. Rowe Price Small-Cap Value and (ACSCX Quote)American Century Small-Cap Value. The good news is there are still several great ones open.

The five funds we profile are worth your hard-earned dollars. Every fund included has long-term returns that leave their small-cap value competition in the dust; managers who have been at the helm for five years or more; and an expense ratio that comes in below the category's 1.55% average. Also, they have no loads -- or additional upfront or back-end fees.

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But first, a quick word on the role of small-cap value funds in your portfolio. Small-cap stocks or funds serve as a useful diversifier in your portfolio to large-cap funds or S&P 500 index funds -- a nice dose of small-caps during the past three years would have offset the dreadful performance of large-cap stocks. Typically, financial planners recommended that small-cap stocks or funds make up about 10% to 15% of your portfolio. You should split that amount between value and growth offerings.

1. (ARGFX Quote)Ariel Fund

You don't have to dig deep to understand the investment philosophy of the $1.19 billion-in-assets Ariel Fund. The firm's trademark is a turtle, its motto is "Slow and Steady Wins the Race" and its Web site includes a link to Aesop's Tortoise and the Hare fable. For investors in Ariel, the story has been more fairy-tale than fable: The fund's one-, three-, five- and 10-year returns are all better than the industry average.