Three All-Weather Small-Growth Funds
In this sometimes dodgy category, stability is a real plus.
The cliché that every cloud has a silver lining is of cold comfort when the stock market drops, but it's true. For it's mainly in downturns that investors can actually see how well a fund plays defense. Most managers will say that they use "risk controls," but clearly some funds hold up better in tough times than others.
Of the nine domestic, style-box-based equity categories, the one most prone to sharp, quick losses is the small-growth group. Given that small caps tend to be more volatile than large caps and that dropping valuations hit growth funds harder than value funds, this behavior makes sense intuitively. And as if to prove the point, the small-growth category has fallen harder this year than the eight other diversified U.S. categories: Through May 19, 2005, the average small-growth fund has fallen 6%.
It wasn't so long ago, however, that small-growth funds were performing quite nicely. On average, these funds gained 12% in 2004 and 45% in 2003. When the economy is growing and the market's moving upward with that growth, small-growth funds have tremendous potential for heady gains.
Given all this recent history, the market has given investors some handy data to use in finding a small growth fund with a good risk-reward profile. Locating funds that have held up better than the average rival in this gloomy year as well as in the rosy 2003 campaign is a good starting point. It's worth noting at this point that we're not saying that this is a particularly good time to buy small-growth funds; if the downturn continues, small-growth funds stand a good chance of continuing to lag. So you might put any funds you find on a shopping list or consider using dollar-cost-averaging to wade in slowly. Or, maybe you're a patient long-term investor who has no small-growth exposure or is looking to find a better option than the one you own currently in a diversified portfolio.
In order to locate small-growth funds that have recently outperformed in good times and bad, we'll use the Morningstar Premium Fund Screener. Unlike some of the screens we run in Five-Star Investor columns, this one is pretty straightforward.
1. "Fund Category = Small Growth"
2. "Distinct Portfolio = Yes"
Inserting this line--which we use in almost every screen--means you only see one share class for each fund. The one, you'll see, has the longest record.
3. "YTD Return % Rank Category <= 50"
As mentioned above, it's been a very tough year for small-growth funds. So we'll simply look for funds that have outperformed. Note that depending on your risk tolerance, you can adjust this number. You could, for instance, avoid only the bottom third of the category or demand that funds be in the top quartile. Also, you might want to look at other tough times, 2002 for instance, to check out funds that come through the screen.
4. "2003 Annual Return % Rank Category <= 50"
Once again, 2003 was a great year for most diversified equity funds, and particularly for small-growth funds. A lot of small firms abandoned in the bear market--because many thought they'd go out of business--came roaring back as the economy picked up steam. If the fund's been around since the late 1990s, you might take a look at 1999, another super year for small-growth funds.
5. "Fund Manager Tenure >=3"
Especially when we're looking at specific time periods, we use a manager tenure line to ensure that the record we're looking at belongs to the manager in place now.
6. "Closed to New Investment = No"
Because it's no fun to find a great fund that you can't purchase, we omit funds that are closed to new investors.
7. "Expense Ratio <= 1.5"
Small-growth funds are often pretty pricey, so this number is higher than it would be for a lot of categories. Funds with front-end loads are often even more expensive than 1.5%. No-load funds should be cheaper than this mark.
As of May 20, 2005, the search yields 22 results. Click here to run this screen for yourself.
Before describing a few of these funds in detail, it's worth noting that some of the largest funds in the category make it through this screen. With small-cap funds in particular, we often caution against big funds due to asset bloat. In general, the larger the asset base, the less nimble a fund becomes. And in small caps, larger funds tend to add more holdings, move up into mid-caps, or both. Finally, liquidity starts to become a problem. However, among the funds that pass this screen are the $13 billion Columbia Acorn fund (ACRNX), the $12 billion American Funds Smallcap World fund (SMCWX), the $9 billion Vanguard Explorer fund (VEXPX), and the $5 billion T. Rowe Price New Horizons fund (PRNHX). Those are the four biggest funds in the category. It's hard to expect such a fund to have truly standout performance in heady rallies, but it's very easy to see why they hold up well in downturns. They are broadly diversified by stock and sector, unlikely to hold as many risky micro-caps, and often a bit cheaper than peers.
Century Small Cap Select Institutional (CSMCX)
No doubt about it, this fund has been on a roll. First its 22% annualized return for the five-year period between Jan. 1, 2000, and Dec. 31, 2004, landed in the top 1% of its category. And now this little number has managed to hold up better than any peer in the tough 2005 environment. Of course, when you buy a fund, you can't get past results, but you must think about the future. While it's hard to envision this fund continuing such a streak, it's easy to see how it can continue outperforming peers. Manager Lanny Thorndike is all about organic growth. He looks for small firms that produce lots of cash from operations--not from outside financing. That keeps him clear of firms that are on the verge of bankruptcy, most risky one-product firms, and the dreaded story stocks that have a plan but no execution.
ColumbiaAcorn USA (LAUAX)
We see this fund as the best domestic offering from Columbia Wanger Asset Management, which has produced excellent results in the small-growth arena for decades. The flagship Acorn fund (ACRNX) also passes our screen, but, given its immense size, we'd buy this one instead. Both funds feature the same growth-at-a-reasonable price approach, a large, experienced analyst staff, and a buy-and-hold philosophy that has dependably produced a smooth ride for investors. Unlike the largely analyst-run Acorn, this one has a traditional manager, Rob Mohn, who himself boasts plenty of experience. It's worth noting that the cheap, no-load Z shares are available only to a small subset of investors, while the A shares cost a somewhat pricey 1.52%--which happens to be below the front-load category average for small growth funds.
T. Rowe Price New Horizons (PRNHX)
This fund's a standout in two areas that we think are really important: stability and cost. Jack Laporte has managed the fund since 1987, and the fund's expense ratio is only 0.87%. Just as crucially, the fund features the steady style that's the hallmark of T. Rowe Price funds. The fund is widely diversified, holding nearly 300 stocks. He uses a growth-at-a-reasonable-price approach, which makes it more moderate than highly aggressive peers. It is worth noting that while the fund did well in 2003, it lagged the majority of peers in 1999. It won't always be highly competitive in big rallies.
Todd Trubey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.