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Fund Spy: Morningstar Medalist Edition

5 Small-Cap Medalists for Your Radar

It's necessary to be selective, but there are some good actively managed small-cap funds still open to new investors.

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Small-cap stocks offer unique challenges and opportunities for active managers. These stocks attract less attention than their larger counterparts. This should lead to more frequent and potentially larger deviations from fair value, creating greater opportunities for savvy investors. Yet, similar to their large-cap counterparts, most small-cap active managers failed to beat their index peers over the trailing 10 years through June 2015, according to Morningstar's most recent Active/Passive Barometer report (1). This isn't surprising because, in aggregate, active managers' portfolios look a lot like their index peers and they carry higher fees. But there are some compelling options.

Finding them can be challenging because responsible shops close their funds to new investors as they reach capacity to prevent asset bloat, which could increase transaction costs or force the managers to modify their strategy. And because assets gravitate toward successful managers, some of the best strategies are closed to new investors. So small-cap investors need to identify skilled managers early or invest with managers who have recently reopened their funds, typically after a period of lackluster performance. The cost of making a mistake can be higher here than among large-cap funds because most small-cap funds have a bigger fee hurdle to overcome. Greater mispricing in this market segment can also hurt unskilled investors more.

Alex Bryan has a position in the following securities mentioned above: RYSEX. Find out about Morningstar’s editorial policies.