Small things have a way of overmastering the great. -- Sonya Levien
Here are three reasons why investors should be looking into small-cap growth funds right now.
Reason #1: The Short Term.
In 2002, the small-cap growth sector performed horribly. The average small growth fund lost 28.4%. If you believe stocks are slowly emerging from the brutal bear market, then small-cap growth may be in pole position to recover. In the 15 months after the 1973-74 bear market, the small-cap growth arena returned 45.2% -- outperforming small-cap value and large-cap stocks by seven percentage points, according to Ibbotson Associates. Small-cap growth also outpaced the rest of the market during the five months after the 1982 bottom and the 12 months after the 1990 bottom.
Reason #2: The Long Term.
Small-cap stocks outperform. Period. From 1926 to 2002, large-cap stocks had a compound annual return of 10.2%; small-caps returned 12.1%, according to Ibbotson. And because they spent most of the 1990s lagging large-caps -- small-caps have never underperformed as much as they did at decade's end -- the category should get some extra juice from reversion to historical norms.
"We expect small- and mid-cap stocks will continue to rebound and will revert to their long-term premiums against large-cap stocks," said James O'Shaughnessy of Bear Stearns Asset Management. "Our forecast for the real rate of return to small- and mid-cap stocks through 2022 is 7% to 11% a year." He expects the
to return between 3% and 5% during that period.
Reason #3: Diversification.
Many investors still have too much large-cap in their portfolios, and that's exactly the place you don't want to be overexposed. A generous helping of small- and mid-cap stocks, both growth and value variety, will help you achieve the right balance. O'Shaughnessy suggests investors should have at least 15% of their total portfolio in smaller-cap stocks -- a little more for long-term investors who seek higher returns. Take a look at your quarterly statement: Do you have enough small-cap in your diet?
That's the focus of this week's Five Funds. Earlier we discussed
small-cap value funds. This week we've unearthed five sound small growth funds that have notched stellar performance with steady hands at the wheel.
But first, a few quick general items about small-cap growth. As you might expect, these mutual funds hunt for companies with less than $1.5 billion or so in market capitalization that look poised to grow significantly -- as Aeschylus says, from a small seed a mighty trunk may grow. This is 10-bagger territory, but it's also loaded with pitfalls. Investors should seek out small-cap funds that have outstanding long-term performance with tenured managers.
Investors also need to worry about asset size in small-capville: A fund that has taken on too much money may have difficulty maneuvering. Some stellar small-cap growth funds, wary of asset bloat, have closed to new investors, including some great offerings from the Wasatch fund family.
Those that remain open after taking in a lot of money either have to put more cash in their holdings and run the risk of being overexposed to a few small companies, or buy a slew of new stocks and dilute their best picks. Less than $1.5 billion in assets is optimal for this category, but don't let dogma get in the way of stellar funds. There are funds on this list that have more assets, but they have been big for a while and have demonstrated that they can handle it.
Without further ado, here are five small-cap growth funds that have notched great long-term results, kept costs down and maintained steady leadership.
1. (ACRNX) - Get Columbia Acorn Inst Report Liberty Acorn
Ralph Wanger is one of my favorite fund managers -- and not just because of his dry wit, which is on display in this recent
10 Questions interview. He has been at the helm of this fund since 1970 -- he was joined by co-manager Charles McQuaid in 1995 -- and has proven his mettle time and time again.
The no-load Acorn has the returns to prove it -- his one-, three-, five- and 10-year returns are in the top decile of all small-cap growth funds. Acorn's 10-year average annual return of 11.6% beats 95% of its peers. Wanger has managed this impressive track record by straying from the herd, avoiding inordinate risks and sticking with long-term winners such as
International Game Technology
Expeditors International of Washington
The fund has $5.68 billion in assets, but Wanger and McQuaid spread their assets over more than 250 companies and haven't shown any diminution of skills because of the large asset base. The skippers also have kept turnover low, which has helped keep expenses down. The expense ratio of 0.82% is half as much as the 1.66% category average.
Full disclosure: This is the small-cap growth fund I own in my IRA.
2. (MERDX) - Get Meridian Growth Legacy Report Meridian Growth
I have a soft spot for solid funds like Rick Aster's $308 million-in-assets Meridian Growth that underperformed in 1999. Why? Because that year marked the height of insanity -- the returns, which Morningstar provides, are the easiest way to tell if a fund manager refuses to follow the crowd when it's deluded.
Meridian's 13.3% return in 1999 was topped by 88% of all small-cap growth funds, but the fund has more than made up for it this decade. Its three-year average annual return of 3.13% places it in the top 2% of all small growth funds, and its one-, five- and 10-year returns (9.88% average annual) are all within the top 15% of its peers.
As you might expect, Aster -- at the helm since 1984 -- takes a conservative approach to growth, refusing to pay too much for hot stocks or sectors. That has led him to load up his fund -- which holds 45 stocks -- on retailers like
and restaurants like
. Look elsewhere for aggressive growth during the market's heady bull runs.
If you're looking for steady long-term growth, excellent management and lower expenses (a 1.06% expense ratio), no-load Meridian Growth is a good pick.
3. (BGRFX) - Get Baron Growth Retail Report Baron Growth
An offering with a similar M.O. is the $941 million-in-assets Baron Growth fund. Like Meridian, it has an assured skipper, below-average costs and a great track record.
Ron Baron, at the helm since the no-load fund's 1995 inception, has shied away from the pricey tech sector, which has kept returns steady and better than peers. The fund's one-year return of negative 18.59% and three-year average annual return of negative 3.5% are among the top 3% and 5% of its peers, respectively. Over five years, it has returned a positive 4.21%, good for the top 11%.
Baron Growth holds 85 companies under its hood, but the skipper isn't afraid to take bigger bets on individual stocks, such as doughnut king
and auto-insurance service outfit
The fund sports a below-average 1.35% expense ratio.
4. (VEXPX) - Get Vanguard Explorer Inv Report Vanguard Explorer
Vanguard Explorer delivers on just what you would expect: low costs.
The $3.76 billion-in-assets fund has an expense ratio of 0.72%, but that is far from its only virtue. For that low price, you get a seasoned roster of five managers -- including John J. Granahan and George Sauter among the subadvisers Vanguard hires for Explorer -- with a combined 35 years at the helm. You also get short- and long-term performance above the category average. The fund's three-, five- and 10-year returns (8.13% average annual) hover around the top quartile of its category, according to Morningstar.
The fund holds a massive 900 stocks, which makes it an ad hoc low-cost small-cap growth index. No company makes up more than 1% of the fund, so blowups are tempests in a teacup here. For investors looking for one-stop exposure to small-cap growth that offers decent returns and keeps volatility in check, Vanguard Explorer is a sound option.
5. (BUFSX) - Get Buffalo Small Cap Investor Report Buffalo Small-Cap
Buffalo Small-Cap is not quite five years old -- its birthday is next month -- but it merits inclusion among our Five Funds because of its solid performance and leadership.
The fund, run by Kent Gasaway, Tom Laming and Bob Male since April 1998, made a name for itself by posting 30%-plus returns in 1999, 2000 and 2001. Not many funds can boast that accomplishment. It tumbled along with its peers in 2002, falling 25.8% -- better than 61% of all small-cap funds. Over three years, its average annual loss of 3.4% is among the top 5% of its peers.
One of the most impressive facts about the $671 million Buffalo Small-Cap is how low its turnover rate is -- a mere 6%. Buffalo's managers believe in finding growth stocks such as Ethan Allen and
ITT Educational Services
on the cheap and letting them ride. That helps the skippers keep the expense ratio at a trim 1.06%.
The fund has taken in a lot of new money in the past 12 months, but the managers have thus far inspired confidence in their ability to put it to good use.