After the Fed indicated that they were done with their rate-hiking cycle late last fall, the Russell 2000 index of small companies soared 5.4% in one day, raising the hopes of small-cap investors, reports an article in Barron’s. Smaller companies often need to borrow more money in order to grow, and the higher rates have put them under more pressure.
Still, the smallest companies of the category—microcaps—are still very cheap, even though they stand to benefit the most from a good economy. For example, the Bridgeway Ultra-Small Company Market fund, which invests in the smallest 10% of U.S. companies and has a $144 million average market capitalization—peanuts compared to the iShares Russell 2000 ETF’s $2.2 billion and the SPDR S&P 500 ETF’s $234 billion. As a result of its razor-thin focus, the fund has underperformed with a 4.4% annualized return for the last five years, compared to 6.9% and 13.7% for the Russell 2000 and S&P 500 ETFs, respectively. But in the Bridgeway fund, the average stock’s price-to-book-value ratio is 1.0, as opposed to 1.6 and 3.6 in the Russell 2000 and the S&P 500 funds, respectively, according to the article.
“The value [factor] may work in the large-cap space, but it works much, much better in small-caps, and even better…[in] the microcap space,” Andrew Berkin of Bridgeway Capital Management told Barron’s. Active management plays a large role in the fund’s performance; the firm’s Bridgeway Small-Cap Value fund, in which microcaps make up more than half the fund, has outperformed the majority of its Small Value fund category peers for the last decade. The Wasatch Micro Cap Value fund is another stellar microcap fund, garnering 15.2% annualized returns for the last 15 years and beating out 93% of its peers. Brian Bythrow, who manages the fund, looks for companies with good balance sheets in niche markets where they won’t be trampled by bigger competitors, he told Barron’s.
Another stellar fund on the more traditional value side is Aegis Value; though it’s weathered some volatility, its price-book ratio is a mere 0.8 and the fund has garnered strong returns recently. Franklin MicroCap Value fund is another good choice, according to Barron’s, with a 1.0 price-book ratio and a tight focus on high-quality value stocks that the fund’s manager, Oliver Wong, likes to hold onto for the long term rather than giving into the impatience so many on Wall Street seem prone to. Other funds that the article points to include Oberweis Micro-Cap, Paradigm Micro-Cap, both of which have beaten their peers, as well as the DFA US Micro Cap, which launched in 1981, making it the oldest microcap fund available—though you need a financial advisor to buy into it. All of these funds should flourish along with the economy, the article concludes.