Small-Blend Funds That Go Their Own Ways

A recent Five-Star Investor article that looked at active share among large-blend funds with large asset bases elicited comments from users about applying the metric to other fund categories. Active share, which measures the degree to which a fund's portfolio resembles a benchmark, can help investors distinguish funds that are truly actively managed from those that just charge the higher fees often associated with active management while, in fact, investing like their bogie.

Active share data is not available on Morningstar.com, but using Morningstar's Direct platform, which is aimed at institutional investors, we can apply the metric to various categories. This week we'll take a look at active share among actively managed small-blend funds.

One of the most striking findings of our research on active share is that in general, benchmark-hugging tends to be associated mostly with large-cap funds. This is partly because of the fact that there are hundreds of publicly traded large-cap stocks whereas the number of publicly traded small-cap stocks is in the thousands. (Despite being fewer in number, large-company stocks still account for more than 70% of U.S. market capitalization while small-company stocks make up less than 10%.) With fewer stocks from which to choose, large-cap managers have fewer ways to differentiate their portfolios from the index, at least in terms of stock selection (weightings of various holdings also figure into active share calculations).  

With a much broader universe of stocks from which to choose, a small-cap fund manager has many more options for building a portfolio, and only a fund manager with a very deliberate plan to do so is likely to hew to the index. In fact, a Morningstar analysis of actively managed small-blend funds with at least $500 million in assets found that the vast majority had active share ratings of 90 or better (among funds available to individual investors). For context, a fund with an active share rating of 100 has no overlap with its benchmark, and an index with a rating of 0 has complete overlap. Even the fund with the lowest rating in the group--Dreyfus Select Managers Small Cap Value (DMVAX), with an active share of 78--could hardly be accused of being a closet indexer.

For investors who favor active management in all their holdings, or who prefer indexing for large-cap exposure but think active management makes more sense for small-caps, the good news is that there are plenty of small-blend funds that bear little resemblance to the index. Below is  a list of small-blend funds that have been vetted by Morningstar's fund analysts listed by their active share rating relative to the Russell 2000 index of small-cap stocks, along with what the rating was five years ago to show whether the fund has become more or less indexlike over time. Of course, looking different from the benchmark is no guarantee of strong performance, as you can see by the Morningstar Ratings for funds associated with these names.

Analyst-Rated Small-Blend Funds by Active Share Rating
	Star Rating	Analyst Rating	Fees (%)	Active Share as of 7/15/13	Active Share as of 7/15/08
Royce Special Equity (RYSEX)		Gold	1.13	97.65	96.90
Opnhmr Main St Sml & Md Cp* (OPMSX)		Neutral	1.24	97.45	59.10
Royce Micro-Cap (RYOTX)		Bronze	1.47	96.94	97.48
FMI Focus (FMIOX)		Bronze	1.26	96.08	97.46
Wells Fargo Advtg Sml Cp Val*		Bronze	1.30	95.11	96.48
Fidelity Small Cap Disc (FSCRX)		Gold	1.05	95.00	98.15
Artisan Small Cap Value		Gold	1.22	94.63	93.49
Stratton Small-Cap Value (STSCX)		Bronze	1.19	94.47	95.83
Fidelity Advisor Small Cap* (FSCDX)		Silver	1.06	93.66	97.82
Keeley Small Cap Value*		Neutral	1.39	92.68	89.30
Fidelity Small Cap Stock (FSLCX)		Bronze	0.69	92.05	94.13
Lord Abbett Small Cap Value* (LRSCX)		Neutral	1.23	91.24	92.32
Royce Total Return (RYTRX)		Bronze	1.10	89.07	86.57
Fidelity Stock Selector Sml Cp (FDSCX)		Neutral	1.06	88.85	93.30
Gabelli Small Cap Growth (GABSX)		Neutral	1.41	86.13	88.13
T. Rowe Price Small-Cap Value (PRSVX)		Bronze	0.82	85.23	88.75
Goldman Sachs Sml Cp Value* (GSSMX)		Neutral	1.41	82.32	88.86
* Fund may charge a load. Note: Minimum $500 million in assets; noninstitutional shares only

It's worth remembering that different indexes may produce different active share results, especially with regard to the broad small-cap universe. A fund portfolio that bears little resemblance to the Russell 2000 index may have a slightly different active share relative to a more focused small-cap index, such as the S&P SmallCap 600 or the Morningstar Small Cap Index of about 850 stocks. For example, Parnassus Small-Cap's active share rating is 99.02 relative to the Russell 2000 but 97.51 relative to the Morningstar Small Cap Index. Also, some small-cap indexes, such as the Russell 2000, include the stocks of very small companies that trade infrequently and thus tend to be avoided by small-cap fund managers.

Rating data as of July 16.