Dependable Small-Growth Funds Do Exist

Pity the poor small-growth fund. The category didn't benefit much from the runup in the financial sector or housing industry in the middle of this decade--those areas were primarily seized on by value managers (though some bolder small-growth skippers did invest heavily in rallying energy service firms). And the category was hammered in the October 2007-March 2009 bear market: The typical small-growth fund lost 58%. Finally, the funds have bounced back nicely in the ensuing rally, but the category trails both the large- and mid-growth categories in 2009 through Dec. 11. All told, this is the worst-performing domestic-stock fund category of the nine represented by the Morningstar Style Box over the trailing five years.

Could this category be a contrarian play? Perhaps, but investors would do well to stick with the most-solid funds in the group given its inherent volatility and the sheer number of speculative firms that dot this corner of the style box. To find such funds, we fired up the  Morningstar Premium Fund Screener on Morningstar.com. First, we searched for distinct funds within the category with managers who have been at the helm for at least a decade; veteran skippers should prove particularly valuable in sorting out the keepers and the flashes in the pan in small-growth land. We also wanted funds that charge below-average expense ratios and have outpaced 75% of their category peers over the past 10 years. And while year-to-date relative performance may not be a great asset given the rather speculative nature of the rally, funds that have beaten two thirds of their rivals during the ups and downs of the past three years are quite appealing. Finally, we set the screens to isolate funds that are covered by our fund analysts, are open to investors, and can be purchased for $10,000 or less.

As of Dec. 14, 2009, the Premium Screener returned five funds. To see the results for yourself,  click here.

 Baron Small Cap (BSCFX)

 Brown Capital Management Small Company (BCSIX)

 Pioneer Oak Ridge Small Cap Growth (ORIGX)

 T. Rowe Price New Horizons (PRNHX)

 Wasatch Small Cap Growth (WAAEX)

Jeff Cardon, manager of Wasatch Small Cap Growth, is the longest-tenured skipper of this group--he's run the fund since its 1986 inception, so he's seen numerous trends come and go. He tends to avoid flavor-of-the-moment fare, though. Instead, he and Wasatch's analysts (who have a great deal of expertise analyzing small-cap firms) home in on companies that they believe can generate earnings growth of 15% or better over the next five years. Thus, Cardon is a more patient investor than most of his category rivals, and the fund tends to own companies with relatively stable revenue streams. It won't always look good in rallies led by speculative firms (although it has performed well in 2009's rally), but its long-term results are superb, and moderate volatility has resulted in excellent dollar-weighted returns. Furthermore, Wasatch has long demonstrated a commitment to keeping its funds nimble.

T. Rowe Price New Horizons' manager, Jack LaPorte, is another grizzled veteran in the category. But after 22 years at the helm, he's retiring in March 2010 and Henry Ellenbogen (who's successfully run  T. Rowe Price Media & Telecommunications (PRMTX) since 2005) will take the reins. We don't expect big changes here, though. This fund is cut straight from the classic T. Rowe Price mold: It seeks companies with above-average profit growth at moderate valuations, it's broadly diversified, and it beats out its category norm by a modest margin in most years (resulting in a fine long-term record). Furthermore, the manager transition here will be measured, as is typical at the firm. It was announced nearly a year in advance, and after Ellenbogen takes over in March, LaPorte will sit on the fund's investment committee as an advisor through the end of the year.

Brown Capital Management Small Company's approach is pretty simple: Find companies that can be highly profitable for years on end and hold them for that long. The veteran management team here (the four members' tenures average 12.5 years) will allow its picks to cluster in just a few sectors; 60% of its assets were recently stashed in tech stocks and another 20% in health care. This level of concentration has led to serious dry spells in the past, but the team's focus on companies where it believes it can predict the long-term prospects has kept a lid on volatility. What's more, the fund has beaten 90% of its category peers over three, five, and 10 years.

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