Best Buy and Hold Small-Cap Funds
With small-cap stocks well off their 2018 highs, but making a comeback and trading at the most attractive valuation we’ve seen in years, it’s time for long-term investors to add exposure. Whenever somebody asks me what I would buy if I only wanted to own one small-cap fund, I usually recommend the iShares S&P Small Cap 600 ETF (IJR). As the name implies, the ETF tracks the S&P 600 Small Cap Index, which I much prefer over the Russell 2000 Small Cap Index that’s used as the benchmark against which most small-cap funds are compared.
Why do I like the IJR?
The ETF offers all the attributes I like in the underlying fund, including broad-based exposure to both growth and value small-cap stocks, quality controls that include a profitability screen (four consecutive quarters of profits), no annual reconstitution (so traders can’t game the index) and low cost, including commission-free trading with many discount brokers.
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Most importantly, the IJR has performed better than the broad market over the long term!
Over the last decade it’s up 353%, versus a 232% gain in the S&P 500. Over the last five years it’s up 50%, versus a 45% gain for the S&P 500. And over the last three years it’s up 58%, versus a 42% gain in the S&P 500.
Over shorter time frames the IJR has more mixed performance. Over the last two years the IJR’s gain of 15% lags the 18% gain posted by the S&P 500. But over the last 365 days it has performed “less bad”, dropping just 2.5%, versus a 4.5% drop for the S&P 500.
Naturally, the impact of the market swoon in late 2018 factors into this shorter-term performance quite heavily. But that’s why the door may be open to snag shares of small caps at an attractive price right now.
The IJR is a good core holding for any small-cap stock portfolio. From there, there are two more compelling options to help you round out your small-cap exposure.
Conestoga SMID Cap Fund (CCSMX)
Conestoga’s biggest challenge might be that it’s done so well it has needed to close funds to new investors. That happened last year with its Small-Cap Fund.
However, Conestoga’s SMID Cap Fund includes many of the same companies held in the pure small-cap fund, as well as a variety of high-quality mid-cap stocks. One potential advantage of this fund is that it has more flexibility to hold big winners longer than the small-cap fund since the SMID Cap Fund focuses on a wider range of companies, from $250 million to $12 billion.
I like that the managers invest with conviction, taking positions in only around 50 stocks, and that the investment style, GARP, or “Growth At a Reasonable Price,” is well-suited to the current investing environment. Attributes of a stock that fits the GARP style include valuation that seems reasonable compared to expected earnings growth, a business model with sustainable competitive advantage, and a high ownership by company managers.
Portfolio turnover is around 24%. As of Dec. 31, the CCSMX had posted an annualized gain of -0.08% over a one-year period and 15.8%, 13.9% and 10.2% over two-, three- and four-year periods. In comparison, the Russell 2500 Growth Index posted annualized gains of –7.5%, 7.3%, 8.1% and 6%, respectively, over the same periods.
Conestoga’s SMID Cap Fund is a relatively aggressive fund that will give you targeted exposure to high potential small- and mid-cap stocks. You just might need to start building a position sooner rather than later since the firm’s funds have filled up in the past and could close to new investors.
Cabot Small-Cap Confidential
My Cabot Small-Cap Confidential advisory is different from the two funds just covered since it’s not a fund at all. It’s an advisory service in which I pick the stocks and do the research, and you decide what you want to buy, and at what price. I send you reports on each stock, as well as weekly updates on the state of small-cap stocks and all our positions, and you pay a modest annual or quarterly fee for your subscription.
We manage no money – that part is up to you. It’s a more self-directed option for investors who like a more hands-on approach.
In terms of stock selection Cabot Small-Cap Confidential typically covers 12 to 18 stocks, depending on the market. Most of the stocks covered fall into the broad sectors of either technology or healthcare, and within those sectors I tend to focus on cloud-based software and MedTech stocks. I’ll also cover some stocks that are more consumer-oriented, from time to time.
For any stock to be included it must have the potential to double within two years. And most stocks have a market cap between $250 million and $2.5 billion when first added to the portfolio.
In terms of performance, the average gain (simple average) on stocks sold in 2018 was 44%. And the average gain on positions currently in the portfolio is around 50%. With the market correction late last year most positions are currently rated at buy, including the three most recent portfolio additions, which are all plays on some aspect of emerging medical technologies.
To learn more about Cabot Small-Cap Confidential you can sign up for a subscription here. I’ll also be hosting a webinar with Cabot Wealth Daily’s chief analyst Chris Preston on February 13 at 1:00 p.m. EST in which we’ll be talking about the service, the potential for small-cap stocks to outperform in 2019, and sectors and stocks that you can buy into now to make money in the year ahead. You can learn more about this webinar and reserve your spot by clicking here.
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