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Small Value Funds Sail Along

Now he says that small value funds have all the earmarks of a sector that is suffering from capital shortages. Banks have no interest in loaning to small companies. Venture capitalists are rushing to fund wind turbines -- and ignoring small financial and industrial businesses.

Whether or not Bernstein's argument is on the mark, there is a strong case for holding small-value stocks over the long term. Since 1978, the Russell 2000 Value index, a measure of small value stocks, has returned 13.1% annually, outdoing the Russell 2000 Growth index by more than 4 percentage points.

Academics say that the outperformance is no short-term fluke. Growth stocks tend to be overvalued, and they can fall a long way when earnings disappoint investors. When small value stocks stumble, they don't fall far. Avoiding big losses, value wins the day.

To try small value stocks, look for a fund that has delivered consistent results. A solid choice is Queens Road Small Cap Value (QRSVX), which has returned 5.6% annually during the past five years, outdoing 78% of its peers and outpacing the S&P 500 by 3 percentage points. Portfolio manager Steve Scruggs likes companies with strong balance sheets and steady niches. He buys when the stocks are depressed because of temporary problems.

A favorite stock is Immucor (BLUD), which makes equipment that is used to manage blood in hospitals and donor centers. The company has a strong balance sheet and dominates a reliable niche. But the shares were pummeled after inspectors from the U.S. Food and Drug Administration cited the company for violating manufacturing standards. Scruggs argues that the regulatory problems involve temporary issues that can be solved.

He also likes Hurco (HURC - Get Report), which makes computerized machine tools for metal molds. The company has no debt and a big cash stake. The recession has hurt sales and profits. But the company has loyal customers because the equipment is easy to use, says Scruggs. Sales in Asia are growing, and profits should rebound as the economy recovers.

Another steady fund is Federated Clover Small Value (VSFAX), which has returned 5.8% annually during the past five years.

For diversification, portfolio manager Lawrence Creatura holds a mix of different kinds of stocks. Some holdings are cyclical businesses that fell out of favor when their industries slipped. Other stocks are unloved companies that can grow steadily in the future because of competitive advantages.

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