Mutual funds focusing on small companies have lost money over the past 12 months, while funds holding large-company stocks made money. Even so, small-company ("small-cap") funds are long-term winners. For the 10 years through April 2012:
* Small-cap growth funds returned 5.87% a year, according to Morningstar, while large-cap growth funds returned 4.57%.
* Small-cap value funds returned 6.73% a year while large-cap value funds returned 4.28%.
Over longer time periods, small-caps have generally beaten large-caps. Small companies are riskier than large companies, so investors have been rewarded for taking those risks.
What’s more, small-cap stocks aren’t as well covered by Wall
Street securities analysts as large-caps are covered. Small companies lack the trading volume that brokers need for profitable trading, so brokerage firms don’t devote the resources necessary for comprehensive research. This lack of coverage can lead to an inefficient market, in which investors with more information can post extraordinary returns.
Therefore, the key to small-cap investing, value or growth, is to find a fund that has delivered superior returns over the past 10 years or more. Look for funds that are still managed by the people who delivered those above-average returns–those managers have proven they can unearth undiscovered gems among overlooked companies.
