The Big Screen: Small-Cap Growth Funds That Live Up to Their Name

Buying or holding a small-cap growth fund might be a bitter pill, given the group's current malaise, but some small-cap funds could be an elixir if you've overdosed on big-cap stocks.

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Small-cap growth funds, like most growth funds, typically focus on stocks of the fastest-growing companies in industries with above-average earnings growth. Unlike most growth funds, they focus on the market's small fry -- stock in companies with market capitalization below $2 billion. For comparison, the median market cap of the average big-cap growth fund's portfolio is over $55 billion.

The upshot is that they do most of their fishing in the technology, telecommunications and health care sectors, trying to land the next Microsoft, Qualcomm or Amgen.

It sounds like a worthwhile effort, but like most tech-heavy growth funds they look a little rough these days, down more than 32% over the past year, according to Morningstar. The average small-cap growth fund has 34% of its money in tech stocks, compared to 23% for the S&P 500, which put them in a bad spot when the Nasdaq Composite Index lost half its value over the past 12 months.

What's in a Name? Small-cap growth funds haven't done well on the 'growth' side of the equation in recent days.

Source: Morningstar. Annualized performance figures through March 6.

Still, there are reasons not to ignore these funds, which haven't hauled in much money compared to big-cap funds in recent years. For instance, a long-term, diversified portfolio would have at least 5% to 10% of its money in small-cap stocks if we use the Wilshire 5000 Total Stock Market Index as a yardstick. And these funds did top the S&P 500 in five of the past 10 years, according to Morningstar.

If you want to peruse small-cap funds, the Big Screen has done some modest snooping for you. We combed through 229-fund category, singling out those that beat their average peer over the past one- and three-year periods with the same manager at the helm, according to Morningstar. Then we also yanked out funds that carry an expense ratio above the category's 1.65% average or have an investment minimum north of $10,000.

Fifteen funds made the cut and here are the top 10, ranked by their annualized returns over the past three years.

Leading Small Cap Growth Funds
Fund	3-Year Annualized	1-Year Return
(BNSIX Quote)BNY Hamilton Small Cap Growth	24.3%	-28.5%
(TEGAX Quote)Touchstone Emerging Growth	19.2	-2.8
(VLSCX Quote)Value Line Emerging Opportunities	18.8	-26.5
(BCSIX Quote)Brown Capital Management Small Co.	18.4	-16.6
(WAAEX Quote)Wasatch Small Cap Growth	17.1	1
(RESCX Quote)HSBC Investor Small Cap Equity	16.3	-15.5
(CMSCX Quote)Columbia Small Cap	16.1	-27.9
(SAGWX Quote)Sentinel Small Company A	15.9	18.1
(ACRNX Quote)Liberty Acorn Z	13.9	4.5
(VEXPX Quote)Vanguard Explorer	12.4	-14.5
Avg. Small Cap Growth fund	7.8	-32.6
S&P 500	7.3	-8.8
Source: Morningstar. Annualized performance figures through Mar. 6.

As you might expect, in a time when owning the priciest stocks led to steep losses, the unifying theme of this list is moderation. All of these funds suffered less than their peers in down months over the past three years, earning below-average volatility marks from Morningstar.

Let's look at a few of the funds on our list and a solid fund that slipped through the cracks.

At the top of the list is the no-load (BNSIX Quote)BNY Hamilton Small Cap Growth fund, where John Lui has held the reins since its 1997 inception. There isn't a lot of information available on the Bank of New York fund. Its latest portfolio report to Morningstar dates all the way back to Sept. 30, 1999, and the Bank of New York Web site merely confirms the fund's existence and offers little else.

While Lui has built a solid track record, the fund's 24.3% three-year annualized return beats 95% of its peers, but the dearth of information makes it tough to get very excited.

The no-load (WAAEX Quote)Wasatch Small Cap Growth fund is intriguing because the Salt Lake City firm specializes in small-cap investing. In fact, five of the firm's seven funds focus on small-cap stocks.

With this one, manager Jeff Cardon has run the fund since its 1986 inception, making him one of the category's most tenured managers. Last year the fund finished with overweightings in health and retail stocks, helping it skirt the Nasdaq bloodbath. The fund's long-term record speaks to consistent skill. Over the last one-, three-, five- and 10-year periods, Cardon beats at least 80% of his peers and the S&P 500, according to Morningstar.

Another tenured manager is Ralph Wanger, lead manager of the (ACRNX Quote)Liberty Acorn fund since 1970. Co-manager Charles McQuaid has worked with Wanger since 1978 and became a co-manager back in 1995. The pair run a price-conscious portfolio, spreading the fund's $3.9 billion among more than 200 stocks.

The fund's diversified approach keeps it from being a highflier but can undercut volatility since there's less reliance on each stock. The pair had just 7% of the fund in tech stocks at the end of last year, favoring financial and energy fare. That worked out pretty well, helping to build on an already solid track record. The fund bests at least 80% of its peers and the S&P 500 over the past one-, three-, five- and 10-year periods, according to Morningstar.

One concern might be its large asset base, about 10 times bigger than the average small-cap growth fund's. It's often harder for small-cap funds to build significant positions and move nimbly in the less liquid small-cap market once they top about $1.5 billion.

Asset bloat might be less of an issue for the $4.4 billion (VEXPX Quote)Vanguard Explorer fund, even though it has more money than Wanger's fund. That's because the Vanguard fund is actually five smaller funds -- Vanguard spreads the fund's money among five sub-advisers. The firm's own indexing guru, Gus Sauter, gets some of the money and the rest is spread among small-cap stock-pickers with a range of styles.

With so many chefs, it's not surprising that the fund has more than 800 stocks in its portfolio. That's kept it off most top-10 scorecards, but it has kept it off bottom-10 scorecards, too. The no-load fund has chugged along, beating its peers over the past one-, three-, five- and 10-year periods and its 0.74% expense ratio is among the category's lowest.

Another multimanager fund that's worth a look is the no-load (MGSEX Quote)Managers Special Equity fund -- full disclosure: I've owned shares for five years. The $2.1 billion fund spreads its money among four subadvisers, blending growth and value approaches in the small- and micro-cap markets. The fund has nearly 300 stocks in its portfolio, but it might be a great choice for investors who want one fund to give them broad exposure to different sectors and styles in the small-cap market.

The fund has performed well, too, beating its average peers over the past one-, three-, five- and 10-year periods. Its 17.6% 10-year annualized gain beats the S&P 500 by more than two percentage points and 93% of its peers. It apparently missed our cut simply because its managers' tenures aren't listed in Morningstar's database.

There you have it, a short list of small-cap funds that might appeal to you if you're looking for small-cap exposure, but not inordinate volatility.