These two small-value funds have followed different paths to success in a difficult year for the peer group.
Among Morningstar's diversified domestic-stock fund categories, the small-value peer group has faced the stiffest headwind in 2011. For the year to date through Nov. 28, the category's typical entrant has shed 10.3% of its value.
That nosedive owes in part to the flight to safety that's marked the second half of 2011. According to Morningstar's estimates, more than $53.4 billion has been yanked from U.S. stock funds in the year to date through Oct. 31, with the bulk of outflows coming since June. And with equity investors seeking at least relative stability amid persistent economic uncertainty, the average funds in our large-cap categories have handily surpassed small-cap offerings across the valuation spectrum.
Still, while the small-growth and small-blend groups have suffered in relative and absolute terms this year, those categories' average returns have so far bested the small-value norm. Even within that beaten-down peer group, though, there is a handful of year-to-date winners, including a pair of funds that have followed widely different paths to modest year-to-date gains.
Here's a look at how they've done--and at how they've done it.
ASTON/River Road Independent Value ARIVX
Year-to-Date Total Return Through Nov. 28, 2011: 6.5%
+/- Category: 16
Year-to-Date % Rank in Category: 1
This fund opened for business on New Year's Eve 2010, but its manager, Eric Cinnamond, is an industry veteran with nearly two decades of experience to his credit.
Prior to joining Louisville boutique River Road Asset Management, Cinnamond worked for roughly a dozen years at another small firm, Intrepid Capital Management. At Intrepid, Cinnamond assembled a solid track record at the shop's small-value offering, Intrepid Small Cap ICMAX, which he managed from October 2005 through early September 2010.
Cinnamond's time at the helm of that fund was marked by solid performance and frequent moves into cash. That's also been the case during the early going at the manager's current charge. At the close of October, roughly 45% of the fund's assets were parked in cash. Yet Cinnamond's success doesn't owe merely to timely moves into and out of equities. The manager's preference for financially sturdy firms with ample free cash flow and little debt has also buoyed performance.
Along with the cash flexibility he enjoys, the fund's quality bias allows Cinnamond to make riskier moves elsewhere. The portfolio includes just 32 stocks, for example. And relative to its benchmark, the Russell 2000 Value Index, and to its typical peer, the fund's lineup features an outsize slug of consumer defensive names and significantly underweight stakes in industrial and financials stocks. With cautious positioning that's essentially tailor-made for 2011's turbulence, this young fund has enjoyed a clear glide path to the top of its category.
James Small Cap JASCX
Year-to-Date Total Return Through Nov. 28: 5.1%
+/- Category: 15.4
Year-to-Date % Rank in Category: 1
This fund currently clocks in as the category's number 2 performer, but in at least one respect its showing is even more impressive than that of ASTON/River Road Independent Value: It hasn't had a massive cash stake for a safety net.
Led by a team of seven managers, six of whom have been on board since the offering's October 1998 inception, one clue to the fund's recent success is in its long-term record. Between November 1998 and October 2011, it's been a down-market overachiever, with shareholders suffering just 71% of the category's declines in that period.
True, the fund has paid a price during rallies, picking up just 75% of the category's gains in the stretch. Yet playing effective defense has led to superior risk-adjusted performance versus the fund's typical peer.
During the three-, five-, and 10-year trailing periods through October 2011, the fund has notched low ratings for Morningstar Risk (a gauge of volatility that penalizes poor performance during market downturns). Its standard deviation has been lower than the peer-group norm in each of those time frames, as well. And in the 10-year stretch, no risk adjustment is needed to see the fund's strength: Its annualized return of 9% earns a spot just outside the small-value group's top decile.
Given the anemic (and worse) showing of most stock market sectors this year, the vast majority of the fund's outperformance owes to the team's stock selection. With the firm's share price climbing by 52% on the year, for example, recreational-vehicle concern Polaris Industries PII has been among the fund's top 2011 contributors. Firearms manufacturer Sturm Ruger & Company RGR and biotech firm Ariad Pharmaceuticals ARIA, a pair of triple-digit gainers this year, have also powered the fund's performance.
Has the Bubble Burst?
Although small-value winners like these two funds have been exceedingly rare in 2011, the category's long-term track record remains remarkable: In the 10- and 15-year trailing periods, the peer group has outpaced all other diversified domestic-stock categories. Small-value funds as a group have tumbled to the back of the pack in the five-year period, though. And the category's three-year showing is merely middling.
We may, in other words, be witnessing mean-reversion in action, with investors tacking toward areas of the market where valuations haven't been swollen (at least in relative terms) by years of outperformance.
If so, now may be a fine time for investors who have been impatiently waiting for the category to cool down to consider dialing up their exposure. But while the two funds highlighted above have delivered sterling performance during a tough year, neither ranks among those that Morningstar analysts consider the category's best offerings. Both have above-average expense ratios, for example; James Small Cap has enjoyed only modest outperformance on a since-inception basis; and while Cinnamond is an experienced and successful investor, more time is needed to assess his prospects at a new firm.
Of the four small-value funds Morningstar analysts favor, two are currently closed. However, two others--one of which recently received a Bronze Morningstar Analyst Rating and the other a Silver--remain open to new investors.