3 Off-the-Radar Small-Cap Gems

Every small-cap investor knows why investing in small-fry companies is a smart move. Over time, these more nimble names have outperformed even the bluest of blue-chip stocks. Of course, these higher returns typically come with higher levels of risk, but over a long time frame, small-cap names can really give your portfolio a boost.

If you want in on the red-hot growth power of smaller companies, a mutual fund that invests exclusively in this sector of the market may be your best bet. Below are three relatively undiscovered funds that might be worth a second look for investors in search of small-cap coverage.

Fidelity Small Cap Discovery (FSCRX)
With $600 million in assets, most of which the fund gained from inflows since mid-2009, this fund is quickly shedding its undiscovered status. Charles Myers took over the helm in March 2006, which means he doesn't have a tremendously long track record here. But during his tenure the fund has posted an annualized 2.8% return, compared with a 3.4% loss for the average small-cap blend fund. A reasonable 1.05% expense ratio means that investors won't overpay for the privilege of owning the fund.

Myers keeps an eye out for undervalued names with strong fundamentals. Right now, the fund's largest sector allocation is to financials. Top holdings include insurer Platinum Underwriters Holdings (NYSE: PTP  ) and TCF Financial Corp. (NYSE: TCB  ) . Myers likes Platinum Underwriters because he felt that most of the firm's liabilities were well-documented and known upfront, and that the company was managed fairly conservatively. TCF currently trades at a reasonable discount relative to its industry peers and has a much lower risk profile than its competition. If you're looking for a small-cap fund whose manager subscribes to the Warren Buffett school of investing, look no further than Fidelity Small Cap Discovery.

Homestead Small Company Stock (HSCSX)
Clocking in with a mere $87 million in assets, this fund is tiny but powerful. A management team has led efforts here since the fund's 1998 inception, and those efforts have produced some respectable results for investors. Over the most recent decade, the fund has outranked 77% of its small-blend peers with an annualized 10.7% return.

This fund exemplifies buying and holding for the long run, with a miniscule 9% annual turnover rate. With a semiconcentrated portfolio of just 40 holdings, successful stock picking makes all the difference here.

Currently, management is finding multiple opportunities in the industrial sector, including capital goods manufacturer Manitowoc Co. (NYSE: MTW  ) , aerospace component maker Triumph Group (NYSE: TGI  ) , and Westlake Chemical Corp. (NYSE: WLK  ) . Each of these meets management's criteria for a firm with superior competitive positioning and financial capabilities compared to its peers, as well as the ability to generate opportunities in excess of the competition as the economy slowly improves.

If you don't have a lot of money to invest, Homestead Small Company Stock should be on your radar screen, as the fund offers an ultralow $500 minimum initial purchase, far less than the typical mutual fund. Thanks to its svelte size, this fund should remain nimble and flexible for years to come.

Royce Dividend Value (RYDVX)
While Royce is certainly a household name among small-cap mutual fund investors, not all of its funds are as large as the flagship Royce Premier (RYPRX), with its more than $5 billion in assets. Royce Dividend Value is a relative newcomer to the fund shop's line-up, with an inception date of mid-2004 and a modest $62 million under management.

While most funds on the hunt for dividend-producing names focus exclusively on the large-cap space, this is one of the few funds that looks for smaller-sized dividend payers. Perhaps not surprisingly, financials take up a lot of portfolio space here, including names like real estate investment trust Lexington Realty Trust (NYSE: LXP  ) and investment management firm Federated Investors (NYSE: FII  ) . With dividend yields of 6.3% and 4.5%, respectively, these names represent two of the most attractive high-yielding opportunities in the small-cap space.

Co-managers Chuck Royce and Jay Kaplan have put together a pretty impressive track record over the fund's existence. During the most recent five-year period, the fund put up a 5.4% annualized return, outranking 93% of its peers. Since its inception, Dividend Value has returned an annualized 5.5%, compared with just 2.5% for the Russell 2000 Index. With a 1.49% price tag, this fund isn't super-cheap, and I'd like to see that expense ratio come down just a bit. But for exposure to pint-sized dividend-paying stocks, this fund is one of the best.

No investor should ignore the super growing power of small-cap stocks, and everyone should have at least a minimal allocation to this segment of the market. Fortunately, by owning one or two top-tier mutual funds that focus on small caps, you can get your required exposure to these stocks and still sleep comfortably at night.

For more insider investing and personal financial planning tips, check out the Fool's Rule Your Retirement service, which provides top-notch retirement and mutual fund advice. You can start your free 30-day trial today.

Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. At the time of publication, she did not own any of the funds or companies mentioned herein. Federated Investors is a Motley Fool Inside Value selection. The Fool has a disclosure policy.


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