These Small Funds Are Beating Bigger Names

What many investors may not realize, though, is that the bulk of the mutual-fund world is made up of small fries. Nearly 80% of the funds and share classes listed in our fund screener database hold less than $250 million each. These funds will probably never show up in your retirement account and most investors will never stumble upon them. But some of these Davids are giving the industry's Goliaths a run for their money.

This week's fund screen concentrates on the industry's best small domestic equity funds. That clique includes 9,741 funds and share classes that contain less than $250 million each — one of the largest groups we have ever started with. We quickly whittled down that list to 1,085 after throwing out load funds. When we added in our usual performance and expense criteria we were left with 14 finalists. The funds average just $119 million in assets.

Every mutual fund is a small one when it first begins trading. And there are certain advantages to that size. Small funds can be more flexible when it comes to strategy and crafting a portfolio. They typically don't have a huge corporation looking over their shoulders at every stock pick they make. Small funds, too, don't have to worry about popping the price of a stock when they start building a position in it. Large funds can take weeks to accumulate a certain stock at the right price. Small funds also tend to be homes to managers whose names are on the door or ones that are closely aligned with the fund. In other words, they aren't going anywhere soon. At big fund families, managers can move around every year.

Of course, size does matter in some cases. Every fund must send out annual and quarterly reports and print up prospectuses. A large firm like Vanguard can use its economies of scale to bring down its back-office costs. Independent shops don't have that luxury. Research can also be a problem. Portfolio managers at Janus can tap a small army of analysts that has performed deep research on a long list of companies. A small shop may have one or two staffers or buy most of its research. All that can make it expensive to run a small fund.

That said, the average expense ratio of our finalists is 1%, about a third cheaper than our typical cutoff for fees. As a group the funds are currently trailing the broad market. But they have also returned an average 19.4% over the last five years vs. 11.2% for the Vanguard 500 index fund (VFINX).

The stock market, though, doesn't care whether a fund has $20 million or $20 billion. It will whack either one. We had 30 funds on our list the last time we performed this screen in September. We tightened our performance criteria this time around. (Funds had to be in the top 10% of their category vs. 20% for the last screen.) Even so, many of the funds that made an appearance then wouldn't have made the cut this time, including Manning & Napier Equity Series (EXEYX) and Old Mutual Focus (OBFVX). Previous finalists typically fell out of consideration because their one-year trailing returns dragged down their three-year numbers, too.

Sit Mid Cap Growth (NBNGX) is one that just barely missed the cut. That fund had been making a comeback after doing poorly during the last bear market. Year to date, though, it's slightly trailing the broad market. Morningstar analyst Katherine Yang thinks the fund is worth keeping an eye on. "Investors should expect a few bumps in the road here," she said in her recent write-up on the offering. But, she adds, "[it] looks to be on sturdier ground than it was a few years back." We would expect to see this fund make a return to the screen next time around.

There are some repeat finalists. The managers of Croft Value (CLVFX) will typically look at 1,000 stock ideas in a year. Half of those, though, will be discarded based on valuation. Then they look for companies that have a potential catalyst on the horizon — a new product, a cost-cutting plan that finally pays off with big earnings — that will attract investors to the shares. Croft gets in before that happens, rides the wave and then takes profits. Top holdings include Weyerhaeuser (WY), AIG (AIG) and Deere (DE). Croft's system has worked. The fund has returned an annual 18.1% over the last five years and it has held its own in the recent downturn, too. Year to date the fund has lost 5% while the S&P 500 has dropped almost 7%. In this case it seems size doesn't matter.

The Criteria
The no-load domestic equity funds on our list this week have less than $250 million in assets. Their performance track records put them in the top 10% of their peer groups during the trailing three- and five-year periods. In addition, they are open to new money, require a minimum under $5,000 and charge an annual expense ratio less than 1.5%.