Small Cap Funds in Today’s Economy

Nowadays, with the recession hitting us right where it hurts people are looking at alternate stock funds to improve their portfolio. The traditional large cap funds are falling out of fashion as small cap funds rise to their peak of glory and success. What is in small cap funds that it should capture the common milieus attention so much?

For floating small cap funds in the market you need to have a small initial capitalization in the range of $2billion to $5billion, hence the name small cap funds. Let us look at some statistics to strengthen our argument-

Ibbotson and Associates on the basis of data analyzed between the period 1926 to 1997 has safely concluded that small cap funds out did the general market by the 4.3% every year, that is its performance was better than most other stocks! Now isn’t that an eye opener! Vanguard and Fund Evaluation Group has published in their reports that small cap funds have beaten most other funds in the market, including small cap funds, by a large margin and blended and caused stock portfolios to flourish even during the recessionary periods. The A Fama French company has reported that these funds have done better than the rest of the funds in the market. Even an eminent economists and stock analyst like Peter Lynch (author of the bestseller “One up on the Wall Street”) has made a fortune by holding on the Fidelity Magellan magazine funds while the market went for a toss and the value of his stocks rose much above the large cap ones thereby transforming into large cap funds in due time, and when their market value was realized he sold them. Obviously, a sly man like him won’t do this by chance or fluke. It’s actually a matter of intellect and the process of taking advantage of the loopholes in the stock market rather than mere luck factor that enabled him to achieve this hitherto unimaginable outcome or profit. Let us look at the things that drove him on this silk route-

Lynch understood the inefficiency of the market when it came to investing in Small Cap funds. Most investors are interested in large cap funds, and that’s what their stockbrokers even advice them to do. Stock analysts quite amusingly only list large cap funds when preparing their stock charts. They recommend their clients to invest in large trusted companies, firms that wouldn’t spend a few billion on small cap funds since they are dealing with billion dollar worth assets(which is one the consequences of being associated with a large firm.) They are driven to think that these small investments would not yield them sufficient annual profits, compared to that on large cap funds. And that is exactly where the loophole or logical lapse occurs in their thinking process. This type of inadequate research regarding small caps in turn helps them return more dividends than most other people can think of. Inadequate research means less knowledge about the company and its products, and hence no one can know about its future market potential. Such inefficiency on the part of the investment community leads to massive bargains on the part of the intelligent stockholders.

Most people forget that one can’t hope to create a Multinational company by investing in an already large firm. So investors have to be daring enough to take risks like investing in relatively small capital ventures and who knows that in due time they may make a 300times profit on their investment (as did NASDAQ and Microsoft).

Once small caps grow in size, mutual funds and institutional investments will pour in without any statutory hassles. Coupled with index stocks their value will raise more and more since them larger avenues for development and growth than large capitalization stocks.