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By Christine Benz and Russel Kinnel | 10-14-2013 10:00 AM

Small Bases Not Holding Back These Medalist Funds

Morningstar's Russ Kinnel profiles three Bronze-rated funds that manage to do a lot with a little.

Christine Benz: Hi. I'm Christine Benz for When it comes to mutual funds, good things can come in small packages. Joining me to discuss three hidden-gem mutual funds is Russ Kinnel. He’s director of fund research for Morningstar.

Russ, thank you so much for being her.

Russ Kinnel: Good to be here.

Benz: Russ, to start out let's talk about why being small can be an advantage for mutual funds. Why do you sometimes want to look for those nimble funds with pretty small asset bases?

Kinnel: Well, it means the managers have maximum flexibility to invest the way they want. They can invest in as few stocks as they want. They can go down in market cap. If you look back at some of the best equity funds, you’ll often see in their early days they may have had some of their very best returns.

Benz: Are there categories where you think being small tends to matter more and categories where maybe it isn’t as big an advantage?

Kinnel: I would say equities in general rather than say bonds.

Benz: Why is that, by the way?

Kinnel: Bonds, outside of high yield, won't have a lot of liquidity issues.

Benz: So, they're very liquid.

Kinnel: Yes, and generally bond funds you run with caution in mind, and so it's not like you’d want to have an 8% stake in a single-issuer bond, whereas in equities you might because you want that upside.

Benz: So, equity funds to start, and then within equities, are there any certain categories?

Kinnel: Smaller-cap naturally or multicap; just something where you have more flexibility. For a more focused fund, it might matter a little more. It would matter less for, say, a very diversified large-cap fund, but for more focused or smaller-cap funds, that small asset base can really be an advantage.

Benz: So, the idea from a logistical standpoint is that the manager--because he or she isn’t buying a huge number of shares of, say, a small-cap stock--is not going to move the price of that stock as they buy and sell. Are there any other advantages?

Kinnel: That’s right. There are lower trading costs, but there's also just the greater flexibility. As you see a fund get more assets, you’ll often see them move up in cap; they might have more positions in order to manage that liquidity. But a small fund doesn't have to make those compromises. They can really just look for the best opportunities and invest as they see fit.

Benz: Any disadvantages that you’d note when it comes to sort of very small asset bases?

Kinnel: The biggest one, I would say, is cost because small asset-base expenses tend to be a little higher.

A sneaky one is some of these funds are a little more likely to be killed off. At some point the fund company might give up on them; they might merge them away.

And then I would say the third thing is these are often funds that have relatively short track records, and that's why they're small.

Benz: Let's dive right into this list. You brought three funds to talk about; the first is Virtus Global Opportunities. It's a global-stock fund, and you think that it's actually quite a good pick, even though its asset base is quite small and hasn't attracted much attention yet.

Kinnel: That's right. The story on this is that Virtus bought the fund in 2009, so the record before then doesn't really matter. In this case, comanagers Rajiv Jain and Matt Benkendorf took the fund over then and they’ve done a good job at this fund, just as they have with longer track records at other Virtus funds. What's different here versus their other funds is this is global, so you're getting U.S. We know that they have a very good track record with foreign equities, and so it's the U.S. part that’s a little unproven. But still you have a small asset base, very good managers, and a good conservative strategy.

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