Good Things Come in These Small (Fund) Packages

Sometimes in investing, size does matter, but that doesn't mean bigger is always better. In fact, sometimes the Davids have advantages over the Goliaths.

For example, let's say the manager of a $50 billion fund wants to reposition his or her portfolio, adding a greater allocation to foreign stocks. Each 1% shift in allocation represents a $500 million shift in assets into whatever foreign companies the fund manager finds attractive. Such a large move into a handful of stocks is likely to make waves in the companies' stock prices, potentially making the shares more expensive in the process. Now multiply that effect by 5 or 10 times to represent a substantial shift in the fund's foreign-stock allocation, and you'll start to understand why the biggest funds, like the biggest ships, take great effort and planning to chart a new course.

Now contrast that with a smaller, more nimble fund undergoing a similar repositioning exercise. Its $1 billion (or less) asset base requires just $10 million to shift its portfolio 1%. That might be barely enough to make a ripple in the trading price of a company it wants to add to its portfolio. Think of this smaller fund as more like a PT boat, skimming along the surface, able to turn on a dime while watching the big boats lumber along. The small fund's advantages are even more pronounced when investing in small- and mid-cap stocks, where a large fund's giant asset base can make the biggest waves.

When a storm hits--in the form of an unforeseen natural disaster or other type of market shock--the PT boat (smaller fund) will have a much easier time steering to safer waters--for example, moving assets into less volatile stocks--while the tanker ship (larger fund) has a much tougher time. Likewise, in a market upswing the small fund has the ability to take advantage of changing conditions much more rapidly than its larger counterpart.

Shortly after the introduction of the Morningstar Analyst Rating for funds system late last year, my colleague Christine Benz took a look at smaller funds (those with $500 million asset bases or less) with Gold or Silver Analyst Ratings. With new Analyst Ratings coming on line all the time, we decided to revisit the topic but loosen the asset-base restriction somewhat.

Using Morningstar's  Premium Fund Screener, we searched on no-load funds with asset bases of no more than $1 billion. To weed out a few smaller target-date funds, categories where being nimble is unlikely to be a long-term competitive advantage, we eliminated the balanced fund asset class. The results are an eclectic mix of funds from categories across the market-cap spectrum, including world- and foreign-stock offerings that may appeal to those looking for nimble funds navigating investments overseas. Below are two of the funds on the list, which Premium users can view  here.

 Matthews Asia Growth (MPACX) (
)This Asia-focused fund, from a company known for its expertise in the region, holds more than 40% of its portfolio in the emerging markets and another 33% in Japan. It has an overweighting in Indonesia and Thailand compared with its competitors. The fund's managers consider opportunities in the region's smaller markets, with a focus on companies poised to benefit from rising income levels. The fund has achieved top quartile results versus its peers in each of the past four calendar years. Its 1.19% expense ratio is low for its category. 

 Buffalo Mid Cap (BUFMX) (
)This quirky fund follows a theme-driven approach based on sectors and stocks its managers expect to succeed in the coming three- to five-year period. For example, among the 35-50 stocks held by the fund are  Chipotle Mexican Grill (CMG), in keeping with the fund's healthy-eating theme. The fund searches for stocks with wide moats, solid management teams, and earnings growth across a market cycle. It tends to focus on consumer cyclical, technology, and health-care stocks while avoiding energy, basic materials, and telecommunications. The fund's 10-year annualized return of 7.7% beats its mid-cap peers by 1.7 percentage points, though performance has been mediocre the past couple of years. Its 1.02% expense ratio is below-average for the category. 

Portfolio data as of Dec. 31, 2011.