U.S. News is releasing a series of stories highlighting top-rated mutual funds according to various categories. These funds have performed well over the long term, are rated highly among the industry's analysts, and have low minimum investments, making them accessible to all investors—big or small. This is the seventh piece in a series of stories highlighting 10 categories that make up U.S. News's 100 Best Mutual Funds for the Long Term.
Large companies may occupy the limelight in your portfolio, but it's important that you also make room for mid- and small-cap stocks. These smaller companies, which include fast-growing businesses, can add a dose of risk and diversification to your investments.
"Over the very long term, the data has shown that small-cap stocks are more volatile and have gained more than large-cap stocks," says Morningstar fund analyst Greg Carlson. From January 1926 through November 2010, large-cap stocks have returned an annualized 10 percent, while small-cap stocks have gained an annualized 12 percent, according to Morningstar. Lately, the performance of small caps versus large caps has been even more pronounced. The average small-cap blend fund—which invests in both value and growth stocks—has returned 26 percent so far this year, on top of an average gain of 32 percent in 2009. The S&P 500, meanwhile, is up about 13 percent year-to-date and gained 26 percent in 2009. (In 2008, the S&P 500 and the average small-cap blend fund each lost 37 percent.)
Small-cap funds' relative outperformance in recent years has some prognosticators placing bets on a revival in shares of larger companies over the next few months since small-cap stocks generally lead the pack coming out of recessions, Carlson says. But he suggests maintaining a healthy allocation to smaller names as a part of a long-term diversified investing strategy.
When evaluating funds in this category, investors should pay attention to the portfolio's average market capitalization. That's because some managers focus on the tiniest companies—called micro-caps—while others may invest in anything that isn't considered a large-cap stock. The size of the fund—in terms of assets—is also important, because asset bloat can hinder a manager's ability to move in and out of positions. "Some funds get too big ... and they either move their market-cap emphasis upward, or sometimes they struggle a bit," Carlson says.
With that in mind, here are U.S. News's best small-cap blend funds for the long term:
Royce Micro-Cap (symbol RYOTX). Because of its micro-cap focus, this fund can be quite volatile at times. In 2008, it plummeted more than 40 percent and landed near the bottom of its category. But from the market's low on March 6, 2009, to its most recent peak on April 23, 2010, the fund doubled in value, according to Morningstar. Although Royce Micro-Cap's main focus is U.S. stocks, management can invest a substantial amount of assets overseas. Almost a third of assets currently reside in foreign stocks, with a small portion in emerging markets like China and India. Over the past 10 years, the fund has returned an annualized 13 percent. Its annual fees are 1.54 percent.
Fidelity Small-Cap Stock (FSLCX). Since Andy Sassine took the reins of this fund in July 2008, it has outperformed 85 percent of its category peers, according to Morningstar. In recent years, the fund's performance has been volatile. Its 43 percent loss in 2008 was among the steepest in its category, but a whopping 63 percent return in 2009 ranked it among the category's top performers. About 12 percent of the fund's total assets are invested outside of the United States, mostly in developed markets in Europe and Asia. Over the past 10 years, the fund has returned an annualized 9 percent. Its annual fees are 1.23 percent.
T. Rowe Price Small-Cap Stock (OTCFX). In 2008, when many small-cap stocks took a huge beating, this fund fell 33 percent, 3 percentage points less than its average peer. It returned 39 percent in 2009 and is up another 23 percent so far this year, ranking it near the top of its category. Manager Greg McCrickard's buy-and-hold strategy is evident in the fund's low turnover ratio of 28 percent. The fund, which has returned an annualized 8 percent over the past 10 years, charges 0.95 percent in annual fees.