Small caps lead the charge

Markets are off to a strong start this year but have you noticed which stocks are leading the pack? You might be surprised to learn it’s the small caps. As of the close of trading on March 23, the S&P/TSX Small Cap Index was ahead 7.4 per cent so far in 2012. That’s well ahead of the gain of the large-cap S&P/TSX 60 Index which was up 5.4 per cent.

In the U.S. it’s a similar story although more so. The Russell 2000 Index, which tracks a large cross-section of small-cap companies, had gained 12.3 per cent this year as of the March 23 close. The Dow Jones Industrial Average, which reflects the performance of 30 of America’s largest companies, had gained 8.4 per cent while the S&P 500 was up 7.8 per cent. The little guys are stealing the show, at least so far.

Of course, there is no guarantee this pattern will continue. However, historically small-cap stocks have tended to outperform their big brothers during bull markets.

So are we in a new bull market? The way the year has started, you would think so. However, there is still a lot to worry about. Just because Greece got the second tranche of bail-out money does not mean that the European disease has been cured. Ratings agency Fitch downgraded the country’s debt to CCC, one notch above default, after the latest deal was announced and there has been widespread speculation that Greece will have no choice but to eventually leave the eurozone.

To the east, tensions over Iran continue to rise, pushing the price of oil towards US$110 a barrel and raising the spectre of a new armed conflict that could turn nuclear.

But North American markets have been ignoring all that, fuelled by statistics that show the U.S. economy is slowly gaining strength and some strong earnings reports from Wall Street. Unless overseas developments unsettle investors, the rally could continue for a while.

Conservative investors will want to stick with lower-risk alternatives such as large-cap equity funds and bond funds. But those looking to add a little more oomph to their portfolio might want to toss in one or two small-cap funds. Here’s one to consider.

Sentry Small/Mid Cap Income Fund. Unlike most small-cap funds, this one is income-oriented, investing in a portfolio of stocks and trusts that provide cash flow. Some of the equities are former income trusts that converted to corporations such as Progressive Waste Solutions and Transforce. Others are still trusts such as Chemtrade Logistics, Pizza Pizza Royalty Income Fund, and H&R REIT.

The track record is very impressive. Over the five years to Feb. 29, the fund posted an average annual compound rate of return of 12.2 per cent compared to only 1.9 per cent for the category — and that was despite a drop of 24.3 per cent during the worst of the 2008-09 market crash. In the latest one-year period, the gain was 10 per cent compared to an average loss for the category of almost 8 per cent.

Almost three-quarters of the assets are in Canada with about 20 per cent in the U.S. and the rest in bonds and cash. Monthly distributions are $0.05 a unit ($0.60 a year) for a yield of 4.1 per cent based on an NAV of $14.55.

The MER is high at 2.84 per cent but in this case you are getting value for your money. The minimum initial investment is $500 and the code for the front-end A units is NCE721.

Ask a financial advisor if this fund is appropriate for your portfolio.

Adapted from an article that originally appeared in Mutual Funds/ETFs Update, a monthly newsletter that provides advice on fund selection and strategies.

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