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Finding Opportunity in Small Cap Funds' Reversal of Fortune

A stretch of bad performance and outflows could offer an attractive chance to get into these top-rated funds.

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Laura Lallos: Small-cap funds have had a dramatic reversal of fortune so far in 2014. These were the best performers among domestic diversified stock funds last year, and now they are the worst--particularly small-cap growth, which on average is down more than 3% through July.

As [Federal Reserve chair] Janet Yellen recently observed, speculative biotech and small-cap tech names may be overvalued after their great run last year, and we are seeing that shareholders are concerned. We're seeing outflows from these funds. In fact, one of the best funds in the category, Morgan Stanley Small Company Growth [which has a Morningstar Analyst Rating of Gold], is down more than 14%. This is a fund that is run by Dennis Lynch, who we named our Domestic-Stock Fund Manager of the Year last year. This short-term underperformance does not cause us to change our long-term view that this is an excellent holding for shareholders who can stick with it.

Laura Lallos does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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