(PUB) Investing 2016

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Great Small-Cap Funds Morningstar Research | Laura Lallos

Mairs & Power Small Cap MSCFX This young fund doesn’t have a five-year record yet, but it follows Mairs & Power’s long-established strategy of buying and holding financially sound businesses with sustainable competitive advantages that can deliver consistently above-average returns on equity. The resulting high-quality portfolio has shown moderate volatility so far—and is the same strategy that enabled the firm’s all-cap flagship Mairs & Power Growth MPGFX to outperform most of its category peers in 2008 ’s bear market. This fund’s lead manager, Andrew Adams, has been a significant small-cap resource for the Growth fund and is now comanager there. Like its older sibling, this fund emphasizes businesses headquartered nearby in the upper Midwest, where the managers believe they have a research advantage. The fund is backed by a firm that has been an exemplary steward of shareholder capital and is committed to closing this strategy before it gets too large. Neuberger Berman Genesis NBGNX Veterans Judy Vale and Bob D’Alelio implement a long-term, fundamentally driven strategy. They look for small-cap stocks, preferably not too cyclical, that dominate a competitive niche and feature solid balance sheets, strong cash flows, and reason- able valuations, and often hold on to favorites for many years. While the fund sometimes lags when lower-quality stocks lead, its 15 -year returns rank in the top 2% of the small-growth category as of December 2015 , and it has been one of the least volatile funds. A caveat: With more than $10 billion in assets, this is among the largest funds in the cate- gory, even after suffering $5 billion in net outflows in recent years. The managers argue that the fund’s quality bias and low turnover allow them to handle size and outflows relatively easily. Perkins Small Cap Value JSCVX This recently reopened fund has reliably provided downside protection despite some team turnover. The approach focuses first on how much a stock could potentially lose, and the portfolio routinely sports a lower debt/capital ratio and higher returns on invested capital than the Russell 2000 Value Index. That’s helped the fund hold up relatively well in

With small-cap benchmarks lagging larger-cap counterparts, is now a good time to invest in small- cap funds? There is no easy answer—for example, conventional wisdom says that rising interest rates are hard on smaller companies, but then again, the economic growth that often accompanies such increases could be a tailwind. But for most stock investors, it is always a good time to have some small- cap diversification. Still wary? We compiled a list of small-cap Morningstar Medalists that have had lower downside capture ratios relative to the S & P 500 than the Vanguard Small- Cap Index VSMAX has had. Six of the seven funds below had lower downside captures over not only the past three years but also the five- and 10 -year periods. The exception is Mairs & Power Small Cap MSCFX , which doesn’t have a five-year record yet but is likely to continue to be relatively temperate. Conestoga Small Cap CCASX This fund’s managers take a relatively conservative approach to the small-growth universe. They are patient, seeking investments with the potential to appreciate by at least 100% over three to five years, and they tend to hang on to their picks for about that long. They prefer companies with strong fran- chises and at least a 15% return on equity, as well as a debt/total capitalization ratio of less than 40% . They invest with conviction, holding between 40 and 50 names, have much leeway to deviate from the Russell 2000 Growth Index’s sector weightings, and also try to stay fully invested at all times. The result is one of the strongest 10 -year risk-adjusted records in the small-growth Morningstar Category. Below-average expenses and a small asset base add to the fund’s attraction.