Small-cap stocks take great effort to analyze and understand. That’s why we think most investors are better off relying on mutual funds for these types of investments.
The greatest potential for growth in stocks resides firmly in the small cap sector of the market. Unfortunately, smaller companies take much greater effort to analyze and understand. Two factors account for this.
First and simplest, the stock market for large companies is highly efficient. There’s a lot of stock, lots of attention and lots of trading by well-informed investors, especially institutions. These factors keep the prices of larger companies in line with company fortunes so quickly that few investors can find or exploit market mispricing. Skilled money managers can.
Second, small companies can see their fortunes change far more rapidly than larger ones. A turn from early losses to profitability, for example, may be normal in smaller, especially new, companies. Large companies marvel at year-over-year earnings increases of 20 per cent or more. Small companies often see earnings improve multi-fold. This can work both ways, of course, meaning with the potential comes risk.
2 small-cap funds to buy
To study and choose small-company investments, however, requires in-depth analysis, including the crucial examination and assessment of management—that human factor so important to small-business success. It’s a process few individuals can undertake.
We’ve recommended funds that invest in smaller-company stocks in the past. One of these is Fidelity Canadian Opportunities Fund (Series B fund code: FID215(FE)).
This fund focuses on small- and mid-cap companies that are primarily located in Canada. It pursues a contrarian strategy that aims to identify value in out-of-favour stocks.
The fund’s portfolio manager is Hugo Lavallée. Mr. Lavallée joined Fidelity Investment in 2002, and became lead manager of Fidelity Canadian Opportunities in 2008. Before that he was a manager of the fund under Maxime Lemieux for nearly two years.
Under Mr. Lavallée, the fund has delivered a compound annual return of 10.6 per cent in the past 10 years. That ranks in the top fifth percentile of the Canadian equity category. Buy.
Mawer Global Small Cap Fund (Fund code: MAW150(NL)) seeks above-average long-term, risk-adjusted returns by investing primarily in securities of small companies around the world. To achieve this objective, the fund’s portfolio managers systematically create a broadly diversified portfolio of wealth-creating companies with excellent management teams bought at discounts to their intrinsic values.
This is the same formula used by Mawer’s other equity funds. It’s a formula that has worked well with Mawer’s funds, including Global Small Cap Fund, which has a 10-year compound annual growth rate of 14.0 per cent. That ranks in the top eight per cent of all funds in the global small/mid cap equity category. Buy.
This is an edited version of an article that was originally published for subscribers in the March 18, 2022 issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.
Money Reporter, MPL Communications Inc.
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