Small-cap investing has been particularly tricky lately. Any small-cap fund that does well soon attracts investor attention and new inflows. These inflows can often weigh down the fund, reducing management's ability to invest nimbly. Closing the fund may help, but it also shuts out any investors still looking for a small-cap outlet. Fortunately, if you look closely enough, you can find decent, relatively undiscovered small-cap funds that have yet to rack up huge asset loads.
LKCM Small-Cap Equity Fund (LKSCX)
This small-cap fund comes from Luther King Capital Management in Fort Worth, Texas. It's run by co-managers Steve Purvis and firm founder Luther King. King has been with the fund since its 1994 inception, and Purvis has been on board since 1998, so this management team is exceptionally longstanding.
King and Purvis look for small businesses with solid balance sheets and high returns on capital. Their resulting portfolio tends to own high-quality, stable small-cap companies. Right now, firms such as Nuance Communications
LKCM Small-Cap Equity maintains a diversified portfolio, currently placing its largest sector bets in industrial materials (19% of its holdings) and financial services (17%). Performance here has been solid, but not chart-topping, perhaps explaining why the fund has remained somewhat undiscovered. LKCM Small-Cap Equity has posted an 11.4% annualized 10-year return through June 2007, compared to 9.1% for the benchmark Russell 2000 Index. This fund has not been a spectacular performer compared to other small-cap blend funds, usually landing in the middle of the pack, but performance has been consistent and favorable year after year. The only exception was in 2003, when the fund lagged the Russell 2000 Index by more than 12%. However, that year favored highly speculative stocks -- definitely not the order of the day at LKCM.
The fund's reasonable 56% annual turnover and low 0.96% expense ratio add to its overall charms. This fund does have a $10,000 minimum, but if you can pony up the dough, the LKCM Small-Cap Equity fund should make a fine small-cap addition to any investor's portfolio.
TCW Opportunity Fund (TGOIX)
Diane Jaffee has headed this TCW fund since 1995. She and her team scour the small-cap universe for cheaply valued stocks with a catalyst that will increase earnings and share price in the near future. A combination of value and growth strategies places this fund squarely in the small-blend category. Right now, Jaffee favors positions in stocks such as Mattson Technology
Opportunity Fund is currently heavy on the industrial materials sector (22% of assets), and light on energy stocks (only 2% of assets), including many oil companies. With only $114 million in net assets, the fund has retained its flexibility to invest in smaller companies, as evidenced by its tiny average market cap. In fact, the fund holds more micro-cap stocks than it did six or seven years ago. Expenses are reasonable here, too; at 1.16%, they're significantly less than the expense ratio for the average small-cap fund.
This fund is another solid but unspectacular performer. It's posted an annualized 10.6% 10-year return through June 2007, versus 9.1% for the Russell 2000 Index. Recently, Opportunity Fund has been hurt by its lack of oil holdings, which have been on a tear the past few years. The fund lagged in 2004 and again in 2006, partly because of this underweighting. Despite this, the fund has delivered impressive absolute returns, even during the bear market years of 2000 and 2001. This fund's returns probably won't shoot for the moon, but they're also unlikely to end up at the bottom of the small-cap pile.
When choosing any small-cap fund, remember to watch out for asset bloat. If small-cap funds get too large, management has a harder time sticking to its investment strategy. That said, it's unlikely that either fund mentioned here will encounter this issue in the near future. If you're looking for a place to park some of the money you've earmarked for small-cap investing, consider one of these two diamonds in the rough.
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