Top Small-Cap Funds That Buy and Hold
These funds are run by skilled managers who invest in small companies they can hang on to for the long haul.
Our Picks
A buy-and-hold strategy can be a good thing for fund investors. It usually means lower turnover than you'll find in a fund that does a lot of trading, which can mean lower fund-trading costs as well as lower capital gains and, thus, lower tax costs to eat away at your net returns. A fund's low turnover rate may also indicate a manager who is more selective when it comes to stock-picking than one who churns a fund's portfolio in an effort to time the market.
Turnover can also play a role in maintaining a fund's identity. A large-cap company can continue to grow and remain in the large-cap category (which Morningstar defines as companies that fall within the top 70% of U.S. equity market capitalization). But small- and midsized companies (which constitute the bottom 10% and the next 20% of the U.S. market cap, respectively) can outgrow their categories, which can present a problem for funds that own them. Part of the purpose of owning a small- or mid-cap fund for most investors is portfolio diversification, to capitalize on times when those stocks outperform large caps. A small-cap fund that becomes overloaded with larger stocks might no longer behave like a small-cap fund and risks losing its diversifying properties--and some investors--as a result.
Some small-cap fund managers will hold on to stocks even after they grow into mid-cap or large-cap territory because they think the stocks still have room to run. The key, if they hope to retain the fund's small-cap character, is to keep these larger-cap stocks from overwhelming the rest of the portfolio--that is, having an oversized influence on fund performance.
To identify small-cap fund managers who take a buy-and-hold approach and have been vetted by Morningstar's fund analysts, we used the Premium Fund Screener tool to find small-cap funds with turnover ratios of 25% or less (the average turnover for a small-cap fund is around 75%) and Morningstar Analyst Ratings of Bronze or better. We screened out institutional funds and those closed to new investors. We also screened out index funds because they typically have low turnover rates by nature, but for investors who prefer them, Vanguard Small Cap Index (NAESX) and Vanguard Small Cap Value Index (VISVX) are both fine choices. The list of actively managed funds that meet our buy-and-hold criteria can be seen here if you're a Premium Member. The list includes the funds below.
Brown Capital Management Small Company Growth (BCSIX)
One look at this fund's portfolio is all you need to find proof of management's high-patience approach. About half of the fund's top 25 holdings have been in place since at least 2006--including two it has owned since 1993. The fund's concentrated portfolio of about 40 stocks currently is dominated by technology firms (67%). Its veteran management team takes a somewhat unconventional approach, looking for companies earning $250 million or less in operating revenue as opposed to those falling within a specific market-cap range. Management likes firms with increasing and durable revenue streams, strong balance sheets, and defensible competitive advantages.
Stratton Small-Cap Value (STSCX)
This below-the-radar, value-oriented fund invests in stocks with market caps between $250 million and $2 billion, incorporating cash flow-based valuation measures, upward earnings revisions, and a small price-momentum component to weed out stocks in steep decline. Manager Jerry Van Horn buys for the long term and likes firms that have industrywide trends or company-specific restructuring or products in their favor. The fund stumbled in 2009 and 2010 but otherwise has been a good long-term performer.
T. Rowe Price Diversified Small Cap Growth (PRDSX)
Fund manager Sudhir Nanda relies on quantitative stock-picking models, with an emphasis on cash flow-based valuation, earnings quality, and capital allocation. Nanda aims to hold stocks for five years and isn't afraid to hold those he likes well after they've grown into mid-cap range (nearly half the portfolio is in mid-cap stocks, well above the category average of 30%). The fund has been a consistent strong performer since Nanda took over in October 2006, beating 94% of its small-growth peers during that time (as of April 17) and outpacing the category's annual average by nearly 3 percentage points. Low expenses (0.91%) for the small-cap, no-load group are a plus.
Portfolio data as of March 31 for T. Rowe Price Diversified Small Cap Growth and as of April 30 for Brown Capital Management Small Company Growth and Stratton Small-Cap Value. Performance data as of June 17.