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Editor's note: Some funds mentioned in this article are now closed to new investors.
Some small-cap funds have been attracting a lot of attention lately with eye-popping performance. Some have closed their doors to new investors, and some small-value fund managers have reached guru status. Brilliant stock-picking is always valuable in an actively managed fund. Awful stock picking can turn an otherwise good fund into a disaster. But in most cases, the success or failure of the asset class explains the success or failure of the fund.
From 1995 through 2001, the smallest 20 percent of U.S. stocks, measured by market capitalization, produced five years of double-digit returns and two years of single-digit losses.
Indeed, $10,000 invested on December 31, 1994 in the DFA US Micro-Cap Fund (DFSCX) would have grown to $29,518 by the end of May 2002. That’s an annualized return of about 15.6 percent.
For comparison, $10,000 in the DFA US Large Company Fund (DFLCX) also had five double-digit calendar year gains and two losses, starting in 1995. But those large-cap losses were more recent and larger. In addition, this large-cap fund was down 6.6 percent in the first five months of 2002. An investment of $10,000 in this fund would have grown to $25,900 by the end of May, for an annualized return of 13.5 percent.
Many investors have a strong desire to keep things simple. Some believe a small-cap fund is a small-cap fund is a small-cap fund. Wrong! Within the small-cap universe, there are important distinctions that can make big differences in performance. The biggest distinction is between growth and value, as shown in the following table. Year-to-date figures are through June 11.
Those numbers should help explain the returns of many individual small-cap funds. The following table shows returns through June 11 for a selection of small-cap funds, some of which we use in our Model Portfolios and our privately managed accounts. Each fund is identified by a letter in parentheses indicating whether its portfolio is oriented toward growth (G) or value (V).
The table also includes Lipper mutual fund averages for small-cap growth funds and small-cap value funds.
Although there’s quite a range of returns within each style of small-cap investing, the difference between growth and value is obvious in this short period. Every small-cap value fund on the list was up. Only one small-cap growth fund in this group was up.
I think the lesson is clear: When the wind is behind you, you don’t have to be a world-class sailor to look good.
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