The largest sectors held by these two small-cap funds are Industrials and Consumer Cyclicals, areas of growth that have helped pushed fund prices up. But their fundamental characteristics continue to make them good buys.
Homestead Small Company Stock (HSCSX) and T. Rowe Price Diversified Small Cap Growth (PRDSX)
from Dow Theory Forecasts
This year’s sluggish returns for large-cap stocks have some investors thinking small. Through April 14, the average small-cap growth mutual fund had returned 7.1%—tops among all categories of diversified U.S. stock funds. Small-cap blend funds, up 4.4%, have also shined. For comparison, large-cap blend funds are up 2.5%.
Why have small-caps pulled ahead? Some investors worry about large-caps because the strong U.S. dollar has weighed on sales and earnings growth, particularly at the big multinationals that dominate large-cap funds. In contrast, small caps tend to rely less on overseas sales—and stand to benefit from a U.S. economy growing faster than many foreign economies.
Small stocks have also benefited from heightened investor interest in companies with profit momentum. Excluding the beaten-down energy sector, per-share earnings for stocks in the S&P SmallCap 600 Index are projected to increase an average of 8.9% in 2015, versus 6.5% for S&P 500 stocks. To be sure, small stocks are more volatile than large stocks.
And small-caps are not cheap. The average S&P 600 stock trades at 24 times trailing earnings, versus 21 for S&P 500 stocks. Still, looking for opportunities among small-cap funds makes sense. Our proprietary system ranks 407 small-cap funds. The two recommended picks profiled below, have these favorable attributes:
* Scores above 90, or among the top 10%, in our rating system. Ranks reflect total returns for periods up to five years, expense ratios, and risk-adjusted performance.
* Performance that outstripped their peer group over the last three and five years.
* Expense ratios below their category average.
* Modest portfolio turnover ratios, which measure trading activity. Funds that limit trading tend to have lower commission costs and greater tax efficiency.
Homestead Small Company Stock (HSCSX), which invests in growth and value stocks, has a five-year annualized return of 16.3%, ranking it among the top 4% of its peer group. The fund held 59 companies on Feb. 28, with industrials representing 27% of the portfolio.
T. Rowe Price Diversified Small Cap Growth (PRDSX) ranks among the top 9% of its peer group for one- , three- , five- , and 10-year total returns. The fund score is an outstanding 99.
Richard J. Moroney, CFA, Dow Theory Forecasts, www.dowtheory.com, 800-233-5922, April 20, 2015