Small-cap mutual funds have gained significant popularity among investors seeking opportunities in the stock market. These funds focus on investing in companies with relatively small market capitalization, offering the potential for growth and diversification. This article will introduce the world of small-cap mutual funds and their industry, highlight their advantages and risks, and explore alternative investment options.
Understanding Small-Cap Mutual Funds
Small-cap mutual funds invest in companies with a smaller market capitalization compared to large-cap or mid-cap funds. The funds typically hold a market capitalization between $300 million and $2 billion. These funds target stocks of companies that have the potential for significant growth but may also carry higher risks. The small-cap segment is known for its dynamism, innovation, and ability to adapt quickly to changing market conditions. Investing in this sector allows investors to potentially benefit from early-stage growth and capitalize on emerging market trends.
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Best Small-Cap Mutual Funds to Buy as of 7/31/23
TheStreet Ratings’ mutual fund rating model compiles and examines financial data on a monthly basis to gauge a mutual fund’s risk-adjusted return compared to its competitors. These 20 small-cap mutual funds are ranked highest by TheStreet Ratings’ methodology.
Fund Name, Ticker, Overall Rating, (Risk Grade)
Dean Small Cap Value DASCX A+ (B)
LSV Small Cap Value Inv LVAQX A+ (B-)
Ancora Microcap Fund I ANCIX A+ (B-)
Huber Small Cap Value Inv HUSIX A+ (B-)
Royce Small-Cap Port Inv RCPFX A+ (B-)
Acclivity Small Cap Value N AXVNX A+ (B-)
James Advantage Small Cap Value JASCX A+ (B-)
Bridgeway Small Cap Value BRSVX A+ (C+)
Hotchkis and Wiley Small Cap Val Z HWSZX A+ (C+)
Royce Small Cap Value Svc RYVFX A+ (B-)
Hodges Small Intrinsic Val Retail HDSVX A+ (C+)
Applied Finance Explorer Investor AFDVX A+ (C+)
Adirondack Small Cap ADKSX A+ (C+)
Rydex SmCp 600 Pure Value A RYSVX A+ (C+)
DFA US Small Cap Value I Inst DFSVX A+ (C+)
Franklin MicroCap Value A FRMCX A+ (C+)
Fidelity Low Priced Stock K6 FLKSX A+ (B-)
FMI Common Stock Investor FMIMX A+ (C+)
FPA Queens Road Small Cap Value Inv QRSVX A+ (B)
Wilshire Small Co Val Inv DTSVX A+ (C+)
Advantages of Investing in Small-Cap Mutual Funds
Growth Potential: Small-cap companies often have ample room for expansion and can deliver significant growth. They are typically in the early stages of their development, which means their share prices may experience substantial increases as they achieve milestones and gain market recognition.Market Inefficiencies: Due to their smaller size, small-cap stocks are not followed as closely by analysts and institutional investors compared to larger companies. This creates potential opportunities for skilled fund managers to identify undervalued stocks and generate attractive returns.Portfolio Diversification: Investing in small-cap mutual funds can provide diversification benefits to an investor’s overall portfolio. Since small-cap stocks tend to have a lower correlation with large-cap stocks, adding small-cap mutual funds can help reduce portfolio volatility and potentially enhance returns.
Risks of Investing in Small-Cap Mutual Funds
Volatility and Price Fluctuations: Small-cap stocks are often subject to higher price volatility than larger companies. Their share prices can experience significant fluctuations, driven by market sentiment, economic conditions, and company-specific factors. Investors should be prepared for short-term price swings.Liquidity Concerns: Smaller companies may have lower trading volumes, which can impact the liquidity of their stocks. In certain situations, it may be challenging to buy or sell shares at desired prices, particularly during periods of market stress.Higher Risk of Business Failure: Small-cap companies are generally more vulnerable to business risks and economic downturns. They may have limited financial resources and face challenges in accessing capital markets. Investing in small-cap mutual funds requires a long-term perspective and tolerance for potential company failures.
Alternatives to Investing in Small-Cap Mutual Funds
One alternative to small-cap funds is investing in large-cap mutual funds, which focus on established companies with substantial market capitalizations. These funds offer stability and the potential for consistent long-term growth, making them suitable for conservative investors in search of reliable returns.
Another alternative is asset allocation funds, which provide a diversified mix of asset classes, including stocks, bonds, and cash equivalents. By striking a balance between growth and income generation while managing risk, asset allocation funds allow investors to customize their portfolios based on their specific investment goals and risk tolerance.
Bond-only funds are another option, primarily investing in fixed-income securities such as government, corporate, or municipal bonds. These funds provide a steady income stream and are generally less volatile than equity funds, appealing to income-oriented investors or those seeking portfolio diversification.
Lastly, value funds focus on investing in undervalued stocks, targeting companies with solid fundamentals trading below their intrinsic value. Value funds are suitable for investors who believe in a contrarian approach and aim to benefit from potential price appreciation when the market recognizes the true worth of the companies.
The Bottom Line
Small-cap mutual funds offer investors the potential for growth and diversification in the stock market, although they come with higher volatility and risks. They can be a valuable addition to an investment portfolio, providing opportunities for significant returns. Investors seeking alternatives may consider large-cap mutual funds, asset allocation funds, bond funds, or value funds to balance their portfolios and mitigate risk. Assessing individual financial goals, risk tolerance, and consulting with a financial advisor are crucial steps in making informed investment decisions.
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