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2 small-cap stock funds to buy

With small-cap stocks expected to do well in an economic recovery, we like these two small-cap funds for investment now.

Small-cap fund managers look less at statistics and more for quality of management, sources of financing and barriers to entry when selecting stocks for their funds.

Small-cap stocks are enjoying relatively strong returns this year. While the S&P/TSX Composite Index is up 5.9 per cent year to date, the TSX Small Cap Index is up 10.9 per cent and the Venture Composite has gained 21.9 per cent over the same time. And small caps have done well over the past year too. Over this time, the Small Cap Index has risen 23.5 per cent, while the Venture Index is up 87.1 per cent.

But small-cap stocks can go through long periods of relatively lackluster performance. Over the past 10 years, for example, the Small Cap Index has a compound annual growth rate of 1.4 per cent, whereas the TSX Composite’s growth rate for the same time frame is 5.6 per cent.

What’s more, small caps tend to do poorly in difficult markets. In 2018, for instance, the TSX Composite declined 11.8 per cent. In the same year, the Small Cap Index dropped 20.1 per cent and the Venture Index plunged 34.5 per cent.

Small-cap stocks win over the long term

Over really long time frames, however, there is evidence to suggest that small caps are relatively strong performers. Since the stock market’s inception in the US, small caps have outperformed large caps, on average, by four per cent annually.

These statistics suggest that small-cap stocks make a good investment if you have the time to wait out adverse markets. Lately, though, markets have been doing well, and small stocks have been doing particularly well. This may continue this year as the economy recovers, encouraging investors to gravitate to higher-risk stocks in search of superior returns.

We believe mutual funds are the ideal way to invest in small companies. Diversification and professional management are nowhere more important than in the small-cap arena.

Small companies, after all, suffer great volatility of fortune. In the bear market of early 2020, for example, the Small Cap Index lost 47 per cent of its value from its February high to its March low. Over the same period, the TSX Composite lost 38 per cent.

But even in good times, small companies can get into trouble. These companies often simply haven’t the resources to withstand periods of intense competition or poor management. And a small company can disappear or lose out when new ideas arise.

That’s why we look for small-cap fund managers with plenty of experience—people like Joe Jugovic of QV Investors Inc., the manager of Clarington Canadian Small Cap Fund, or Paul Moroz of Mawer Investment Management Ltd. They’re a different breed from their large-cap counterparts. Statistics mean less to them. In their place, quality of management, sources of financing and barriers to entry are more important considerations. And for the investor who invests with these managers, a long time horizon is of paramount importance.

Two small-cap funds to buy

With small-cap stocks expected to do well in an economic recovery, we like these two small-cap funds for investment now:

IA Clarington Canadian Small Cap Fund (Fund code: CCM520 (FE), CCM521 (DSC)) has underperformed its category these past couple of years, but we expect it will do well as the Canadian economy recovers. Buy.

Mawer Global Small Cap Fund (Fund code: MAW150 (NL)) is a consistently strong performer within its category. Buy for exposure to global markets.

This is an edited version of an article that was originally published for subscribers in the February 26, 2021, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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