Good Smaller-Cap World-Stock Funds Are Hard to Find

The case for global smaller-cap funds is clear. Such funds have significant diversification value as well as considerable capital-appreciation potential. The small-cap space is less closely followed and thus less efficient than the large-cap space, particularly outside the United States, so managers of such funds have ample opportunity to add lots of value. That's because these managers have the freedom to go wherever the top smaller companies are, while their U.S., foreign, and regional counterparts do not.

But finding good global smaller-cap funds is much easier said than done. More than three fourths of world-stock funds are large-cap offerings. Most of the rest are all-cap vehicles rather than genuine smaller-cap funds. And even the best of the all-cap world-stock vehicles are unlikely to satisfy investors seeking global small-cap exposure due to their often sizable stakes in large-cap stocks.

Meanwhile, many of the true global smaller-cap funds have one or more flaws that render them unattractive. Some of them are in unproven hands or have seen significant manager turnover in recent years, for example, while others employ overly bold strategies or have posted disappointing results given how well small-cap stocks have performed in the 2000s.

But investors seeking global smaller-cap exposure needn't give up. There are a couple of front-load world-stock funds that focus on smaller caps and are quite attractive overall.

On the no-load side, there is one such offering that has lots of potential. And there are a pair of no-load small-cap domestic-equity funds that pay significant attention to overseas opportunities and are proven winners. Here are the details on all five funds.

Two Fetching Front-Load World-Stock Vehicles
 American Funds SMALLCAP World (SMCWX): This front-load fund has nearly $24 billion in assets, so it is anything but nimble. But it is run by 13 managers who operate independently of each other and follow a variety of fundamentals-driven strategies. Both attributes help offset the challenges of running a small-cap offering with such a huge asset base. The portfolio's average market cap hovers around $2 billion, in fact, so this fund delivers genuine smaller-cap exposure, and the managers are willing to hold some cash, which lowers risk.

Meanwhile, the managers have added value with their stock selection in a mix of climates throughout the 2000s, and this fund has outpaced the typical global smaller-cap offering during the trailing five- and 10-year periods while incurring relatively moderate volatility. An attractive expense ratio of just 1.13% adds to its appeal.

 BlackRock Global Small Cap (MDGCX): This front-load fund takes a relatively temperate approach to investing in smaller firms. Murali Balaraman and John Coyle, who took the helm in March 2005 after serving as analysts for several years, invest in both growth and value stocks, avoid big country bets, and pay ample attention to issue diversification as they pursue small and midsized firms with strong management teams and straightforward business models.

Thanks to the tame aspects of the managers' strategy, as well as the team's skill, this fund has held up much better in sell-offs than have most global small-cap offerings, and it's suffered significantly less volatility overall. And management's reserve has been burdensome in certain rallies, the fund earned a 7.2% annualized return from the time the team took over through May 24, 2011, while the typical global smaller-cap offering posted a 6.2% annualized gain.

One Promising No-Load World-Stock Offering
 Royce Global Value : This no-load fund has an excellent foundation. Royce & Associates has long been a leader in the field of small- and mid-cap investing. Lead manager Whitney George is a veteran of the firm and has produced impressive results as lead manager on  Royce Low Priced Stock  (which is closed to new investors). He focuses on the same types of stocks for all his charges: Smaller caps with strong balance sheets and attractive valuations.

What's more, George has executed his discipline deftly throughout his tenure here. This fairly young fund delivered a 10.6% annualized return from its inception at the end of 2006 through May 24, 2011, while the typical global smaller-cap offering posted a 2.2% annualized gain. This offering has been more volatile than most of its rivals, largely due to George's willingness to build big sector stakes, but it clearly has lots of potential. Its prospects would be even brighter if its expense ratio--which is currently capped at 1.69%--declined significantly. (The median no-load world-stock offering has an expense ratio of 1.23% and the median no-load foreign small/mid cap offering has an expense ratio of 1.37%.)

Two No-Load Domestic-Equity Funds with Broad Purviews and Ample Merit
 Royce Heritage : This no-load small-blend fund, which opened in 1995, also enjoys the benefits of its firm's considerable smaller-cap expertise and resources. It has been run throughout its 15-year history by Chuck Royce, who has decades of experience as a mid-cap, small-cap, and micro-cap manager and who has produced strong long-term results at other family offerings. Royce employs an inherently sound strategy here, pursuing financially strong smaller caps that have seen their stock prices decline due to what he considers to be temporary problems.

Royce has expanded this fund's geographic range as the firm's foreign equity capabilities have expanded in recent years. Indeed, this fund now has roughly one fourth of its assets invested in a diverse mix of international stocks, such as Canada's  Ritchie Bros Auctioneers (RBA), the United Kingdom's Hochschild Mining, and Germany's Pfeiffer Vacuum Technology. Royce has earned terrific results over time here with his increasingly wide-ranging approach. And though this fund's expense ratio of 1.38% is greater than the average for no-load small-cap funds, it is in line with that of the typical no-load foreign small/mid-cap offering.

 Wasatch Small Cap Growth (WAAEX): This no-load fund, which is open to investors buying directly from Wasatch as well as to existing shareholders, has a lot going for it. Wasatch has considerable small-growth expertise. It has delivered the goods at both domestic-equity and international-stock funds. And manager Jeff Cardon, who has been at the helm of this fund since it opened in 1986, is one of the most seasoned and skilled small-growth managers around.

Meanwhile, Cardon, who invests in a mix of fast and steady growers and employs an effective valuation discipline, readily considers foreign companies that meet his exacting standards. The fund currently has more than 20% of its assets in overseas names, in fact, including top-20 holdings Wirecard (a German electronic-payment-services provider) and  HFDC Bank (HDB) (one of India's most diversified private lenders). Cardon's stock selection has been quite good here in the U.S. and abroad in all kinds of conditions over the years, so this fund has earned strong three-, five-, 10-, and 15-year returns with relatively modest volatility. This fund has a reasonable expense ratio of 1.27%.