A Safer Way to Hold Foreign Small-Cap Stocks

NEW YORK (TheStreet) -- Small-cap foreign stocks have been climbing. This year, funds in the foreign small/mid growth category returned 8.4%, compared to a gain of 4.1% for the MSCI EAFE international index, according to Morningstar.

During the past 10 years, the funds returned 10.4% annually, outpacing the S&P 500 by four percentage points.

Seeing the strong results, you may be tempted to buy. But keep in mind that foreign small stocks are among the most volatile assets. In the downturn of 2008, funds in the foreign small/mid growth category lost 49%, according to Morningstar.

Should cautious investors stay away from the small-cap funds? Not necessarily. But to control risk, consider a fund with a record for delivering relatively steady results.

Top choices include Aberdeen Global Small Cap (WVCCX), Columbia Acorn International Select (LAFAX) and MFS International New Discovery (MIDAX). These funds all focus on high-quality businesses with strong balance sheets and reliable earnings.

Columbia Acorn ranks as one of the least risky choices in the category. Portfolio manager Chris Olson looks for companies that can produce consistent earnings growth over long periods. He prefers businesses with little debt and strong cash flows.

The portfolio has 50% of assets in mid-caps, which tend to be more stable than small stocks. During the past five years, the fund returned 0.2% annually, outpacing its average peer by 3.5 percentage points.

While many competitors closely track the benchmarks, the Columbia fund can overweight appealing sectors and avoid risky industries entirely. In 2006, the fund had a big stake in European banks. But with storm clouds appearing, Olson moved away from banks. The shift enabled the fund to outdo 96% of competitors during the turmoil of 2008.

"We sold all the financials because there were just too many questions about the risks that the banks faced," he says.

Olson currently has a big stake in Singapore real estate investment trusts. Holdings include Mappletree Industrial and Ascendas Real Estate, which own premier office parks and facilities that house factories. The stocks yield more than 6% and have strong balance sheets.

While Olson is wary of Europe, he has confidence in Singapore. "Singapore has a well-funded banking system, and the economy is doing fine," he says.

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