NEW YORK ( TheStreet) -- Small stocks were clobbered during the volatile markets of last year. In the third quarter, small blend funds lost 21%, according to Morningstar. For 2011, the funds lost 4.1%, trailing the S&P 500 by 6 percentage points.Investors should not be surprised by the turbulent performance of small-cap funds. Many academic studies have shown that small-cap funds can be more volatile than large stocks. During rough times panicked investors can suddenly dump little-known small stocks and take refuge in giant blue chips, which seem like safer bets. Although they come with risk, small stocks belong in nearly every portfolio because they can deliver strong long-term returns. Small-cap funds have ranked as one of the top-performing categories in recent years. During the past 10 years, small value funds returned 7.7% annually, outdoing the S&P 500 by four percentage points. To find steady small-cap choices, I searched for funds that had outperformed their categories while taking only moderate risks. I started by screening for funds with strong five-year records. To avoid risky choices, I looked for funds with below-average volatility, as indicated by standard deviation, a measure of how much an investment bounces up and down. The winning funds include Hancock Horizon Burkenroad Small Cap ( HHBUX), RS Select Growth ( RSDGX) and Tocqueville Opportunity ( TOPPX). ALGN), which makes clear dental braces. The company is gaining market share because teenagers and adults prefer Align's products instead of the unsightly wires and brackets of traditional braces. The company's sales increased 38% in the most recent quarter. "Align is an industry leader with strong intellectual property and a competitive advantage," says Chadwick-Dunn.
Another holding is Core Laboratories ( CLB), which provides software for oil and gas producers. Core's products help energy companies analyze the characteristics of reserves. The company serves 1,000 fields and is adding 50 new fields a year. SAFM), a Mississippi poultry producer. "This is a simple business that has been a great performer over the last 10 years," says portfolio manager, David Lundgren. Another holding is Tupperware Brands ( TUP), the longtime producer of storage containers and cookware. Based in Florida, the company has been expanding overseas. DNKN), which operates Dunkin' Donuts and Baskin-Robbins outlets. Portfolio manager Thomas Vandeventer says that some investors view Dunkin' Donuts as a mature chain that can only grow slowly. But the company is expanding in states west of the Mississippi where the chain has a limited presence. "The company can grow its topline at a 6% to 8% rate, and the bottom line can grow 15%," Vandeventer says. He also likes Herbalife ( HLF), which sells products that are used for weight management and nutritional supplements. Earnings have been growing at an annual rate of more than 20%.