Small is beautiful

It should come as no shock that precious metals funds were the top performers over the year to November 30, with an average gain of 107.5 per cent.

But here something that may surprise you: Canadian small-cap funds outperformed their big brothers by a wide margin. In fact, apart from gold funds, they were the best place for your money over the past 12 months if you were investing domestically. Take a look at the category averages:

Canadian Small or Mid Cap Equity: +49.6 per cent

Canadian Focused Small/Mid Cap Equity: +40.6 per cent

Canadian Equity: +25.2 per cent

Canadian Focused Equity: +21.5 per cent

Canadian Dividend and Income Equity: +20.1 per cent

That’s right: returns from the two main small/mid-cap categories were almost double those generated by diversified funds and those that focus on large-cap stocks. Dividend funds lagged, hurt by weakness in some financial services stocks, especially insurance companies.

I’ve combed through these categories for the funds that are leading the way in this category. There are many outstanding performers but here are two that stand out.

Beutel Goodman Small Cap Fund. This fund has been on our Mutual Funds Update Recommended List since October 2003 and it continues to be a star. Like virtually all equity funds, it was hit hard by the stock market collapse of 2008-09 but it fared much better than most of its peers. The fund dropped almost 35 per cent in the 12 months to October 31, 2008 but has since staged a powerhouse recovery. Over the year to November 30, 2009 it posted a gain of 62.3 per cent compared to an average advance of 49.6 per cent for the category as a whole. That’s a huge outperformance! Over longer time frames it has done very well for investors with a 10-year average annual compound rate of return of 13.2 per cent, almost double the category average.

Small-cap funds can be highly volatile but this fund is managed more conservatively than most others of its type. The current asset mix favours energy and materials stocks and there is a sprinkling of income trusts in the portfolio. Overall, you’ll find a good blend of growth and value here, along with below-average risk (in relation to small/mid cap funds generally) and good returns. I am maintaining the rating at a well-deserved $$$.

Renaissance Canadian Small-Cap Fund. The Renaissance funds, which are owned by CIBC, aren’t widely known by investors. But they deserve more attention because the organization offers some top-notch performers, this fund being a prime example. It has been one of the stars of the Canadian small-cap scene in recent years, ranking in the top quartile for three out of four years from 2005 to 2008. As of the end of November, it was showing a year-to-date return of 45.3 per cent for 2009.

Manager David Graham invests in companies with a market capitalization of less than $1 billion, which means you may find some fair-sized firms in the portfolio. Some of his picks have been doing extremely well. For example, Silver Wheaton, one of the top 10 holdings in the portfolio, was up almost 300 per cent for the year to November 30. Other big gainers include the little-known Vicwest Income Fund (+168 per cent in one year), top holding Aastra Technologies (+223 per cent), and Red Back Mining (+145 per cent). Just over half the portfolio is invested in the resource sector with the rest well diversified.

Over the decade to November 30, the fund produced an average annual compound rate of return of 12.6 per cent, well ahead of the 7.5 per cent category average. Rankings published on The Fund Library website place it among the ten best performers in its category over that period. The risk level is slightly better than average for a fund of this type. I continue to rate this as one of the top small-cap funds in the country.

The Bottom Line : Small-cap funds are smoking hot, but the risk element is high. Don’t invest in them if you’re uncomfortable with that risk.

Adapted from an article that originally appeared in Mutual Funds Update, a monthly newsletter that provides advice on fund selection and strategies. For subscription information, go here.

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