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Small-Cap Funds That Deliver a Smoother Ride

In a notoriously volatile arena, these quality funds offer lower risk than their peers.

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These days it seems like many investors remain fearful of risk. The punishment of the 2008-09 market drop still on their minds, they've plowed assets into bond funds and sought refuge in alternative investments in an attempt to minimize the likelihood of losing their shirts should the market take another turn for the worse. That makes for a tough environment for small-cap funds, which invest in smaller-company stocks that sometimes outperform large caps but bring increased volatility along for the ride. In 2011 investors pulled about $7 billion out of small-cap funds, and as of the end of July they had pulled another $6 billion out so far this year. The fact that small caps have lagged large caps during that time period certainly plays a role, but investors' lack of appetite for volatility surely does, as well.

Among the many ratings Morningstar provides for funds is a proprietary metric called Morningstar Risk, which ranks funds relative to their peers based on downside volatility (potential losses are emphasized because it is presumed that investors won't mind if a fund tends to be volatile to the upside). The risk ratings are distributed as follows: high (the most risky 10%), above average (next 22.5%), average (middle 35%), below average (next 22.5%), or low (the least risky 10%), with lower ratings corresponding to lower risk and less volatility. Funds are rated over three-, five-, and 10-year time periods when possible. An overall rating (provided only for funds that have not changed categories) uses a weighted average of the given time period ratings. The Morningstar Risk measure also helps determine the Morningstar Rating for funds, commonly known as a fund's star rating. You can read more about this rating methodology by clicking here.

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Adam Zoll has a position in the following securities mentioned above: PRNHX. Find out about Morningstar’s editorial policies.