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Turmoil-Tested Small-Cap Funds

Though these small-cap funds' three-year records aren't terribly inspiring, the offerings' outperformance is a reflection of long-term strength.

Karin Anderson, 11/09/2010

The market conditions of the past three years have whipsawed small-cap funds in a big way.

From the Russell 2000's peak on July 13, 2007, to the market bottom on March 9, 2009, the typical small-cap fund shed 41%, whereas the typical mid- and large-cap funds shed 39% and 37%, respectively. From that bottom through the most recent peak on April 27, the typical small-cap fund surged by 89%, which outpaced its mid- and large-cap counterparts by several percentage points.

Those swings have wreaked havoc with small-cap funds' three-year record. The typical small-cap fund shed 5.7% annualized in the three years ending Aug. 16. That said, the challenge of navigating these turbulent markets was a virtual stress test that, when paired with longer-term performance periods, showed which funds lived up to their reputations and records during the crisis. Combining three- and 10-year results with other factors can help point to some interesting small-cap funds.

For this screen, we use Morningstar Principia to zero in on domestic small-cap funds with below-average expense ratios (below 1.3%) that are open to new investments of $25,000 or less.

Special Criteria = Distinct Portfolios Only
And ( Morningstar category = Small Value
Or Morningstar category = Small Blend
Or Morningstar categroy = Small Growth )
And Audited expense ratio < 1.30
And Purchase Contraints = Closed-New Investment
And Min Initial Purchase < 25,000
And Analysis not= NA

To stress-test the funds' records, look for options with three- and 10-year category rankings that are in the top quartile, and make sure the current manager has been around for at least 10 years.

And % Rank Cat 3 Yr  <  25
And % Rank Cat 10 Yr  <  25
And Manager Tenure (Longest) > 10

We ran the screen on Aug. 19. Here are a few funds that stood out:

Karin Anderson is a senior mutual fund analyst with Morningstar.

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