NEW YORK ( TheStreet) -- Microcap stocks have lagged recently. During the past five years, iShares Russell Microcap Index ETF (IWC) has lost 1% of its value annually, trailing the S&P 500 Index by 3.6 percentage points.
Most of the poor performance can be traced to big losses that microcaps suffered during the recession. As the financial crisis began unfolding in the second half of 2007, tiny stocks were among the first to sink, and they dropped sharply throughout the market downturn of 2008.
While the definition of microcaps varies, many portfolio managers say that the group includes companies with market capitalizations of less than $500 million. In contrast, the average market value of stocks in the S&P 500 is $48 billion.
It is not unusual for microcaps to underperform in downturns. The tiny companies tend to be more volatile and less well-run than the blue chips. Microcaps often face big debt burdens. As a result, the group records more than its share of bankruptcies. When investors began fleeing risk during the recent market downturn, they dumped microcaps. Hedge funds that had to raise cash were among the big sellers.Should you avoid microcap funds? Not necessarily. While microcaps are prone to big downturns and long periods of subpar performance, the stocks tend to compensate by excelling in bull markets and outperforming over the long term. During the past 85 years, microcaps have returned 12.3% annually, compared to 9.4% for large stocks, according to the University of Chicago's Center for Research in Security Prices. The data suggest that investors who want to use a microcap fund should be prepared to wait patiently through downturns and what could be prolonged periods of underperformance. To own a fund that can knock the cover off the ball in a bull market, consider Wasatch Micro Cap Value (WAMVX), which has returned 5.3% annually during the past five years. After crashing in the downturn, the fund gained 70% in 2009, outpacing the S&P 500 by 43 percentage points for the year. Portfolio manager Brian Bythrow is an opportunist, holding a mix of growth and value names. He classifies some of his holdings as fallen angels, growth stocks that have slipped because of temporary problems. Other favorites are value-priced stocks that are beginning to enter a growth phase. Bythrow prefers companies that move under the radar. Many holdings have little or no coverage by analysts.
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV