Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Small-cap stocks can add some oomph to a portfolio, but they also have the potential to add some volatility. Joining me to share some favorite small-cap actively managed stock funds is Russ Kinnel. He's Morningstar's director of manager research. Russ, thank you so much for being here.
Russ Kinnel: Happy to be here.
Benz: Russ, let's talk about small-cap stocks--how investors should approach this because there's some academic data that points to small-cap stocks outperforming the broad market over time, but probably don't want to go crazy with them. You want to right-size your allocation. What's kind of an approximate weighting within my equity portfolio that I might dedicate to small-cap stocks?
Kinnel: Well, small caps represent a little less than 10% of the market, so I think anywhere between 5% and 15% would be a reasonable weight. Obviously, you could go above or below that, but I think that's generally a ballpark figure that works for most people.
Benz: So let's get into some of these funds. They're actively managed. Before we get into them, let's just talk about indexing this space. That's a viable idea as well, right?
Kinnel: That's right. It is a viable idea. Active small-cap funds have done better versus the benchmarks than in large-cap space. So some people who will do large cap passive will go with small caps, but I think both are legitimate ways of investing in the small-cap area.
Benz: We're going to look at some of your favorites. Let's start with Mairs & Powers Small Cap. People might be familiar with Mairs & Power Growth, which is a large cap-oriented fund. This one lands in the small-cap blend category, and it's Silver-rated. Let's talk about what you like about it.
Kinnel: It reopened in the fall of last year. So I always like to get funds after they reopen. It's a bit of a contrarian signal.
Benz: Why is that?
Kinnel: Well, because generally you're reopening because investors have gone out of the fund a little bit, which is often a signal that it may be time to get in. And this fund actually closed at a very low level anyway, so I think actually they're very prudent about managing that asset base. It's a fund that looks for companies with sustainable competitive advantages, and it has a bit of a defensive characteristic to it, so that in most down markets, it loses less, which I like a lot.
Benz: Right. Another thing about it, like all of the Mairs & Power funds, it focuses on companies that are based kind of in its general environs, so in the Midwest. What's going on there, and what's the thesis there?
Kinnel: Yeah. It's a little quirky. They're based in Minnesota, and they invest in a lot of companies that are not far from Minnesota, which is a little odd, but at the same time, they do a great job with it. As I mentioned, the portfolio is fairly defensive, so it's not like you're being exposed to extreme risks. Again, we talked at the beginning about how this--Say your total small-cap exposure is 5% to 15%, and let's say this is one of two, then that means a fairly small part of your portfolio. So, I don't think it is that big a deal that they have this unusual regional focus. They're not exclusively dedicated to the Midwest, but it's mostly in Midwest.
Benz: So you mentioned that that one tends to be kind of a mild-mannered fund, a good performer on the downside. Loomis Sayles Small Cap Growth definitely runs toward the more aggressive side of the spectrum within the small-cap space. Let's talk about it and why you and the team like its strategy.
Kinnel: It's also recently reopened, also Silver-rated. Managers Mark Burns and John Slavik have run the fund since 2005, so really nice track record, really kind of a classic growth strategy. And, again, as the fact that they were closed and then reopened indicates they are mindful of their capacity, which is a huge thing, especially in small growth because small growth is also another word for momentum, really. Small-cap companies are growing well. All of a sudden, momentum trade piles in and it can push it up and down very quickly, and so capacity is really important here.
Benz: Finally, let's discuss LSV Small Cap Value. This one, too, is Silver-rated. This is a quantitatively managed fund, and I guess the question is: There have been so many new factor-based ETFs that in some ways kind of replicate quant strategies, at least in my mind. How does this fund, do you think, add value within this increasingly crowded space?
Kinnel: That's right. There're a lot of ETFs, a lot of strategic-beta variations that you can find out there and that I think raise the bar for any kind of quantitative strategy, but this one isn't simply one or two screens. This is a firm that employs a lot of Ph.D.s, who do a reasonable job of building models, and they keep updating things, but they also don't seem to be the kind who chase every last factor down. So, I think you got a nice well-built portfolio from this process. It cost a little more, but if you look at the long-term performance record, it would seem to justify it.
Benz: Okay, Russ, I know our viewers always love to get your picks. Thank you so much for being here.
Kinnel: You're welcome.
Benz: Thanks for watching. I'm Christine Benz for morningstar.com.