Small-cap value funds see stunning rally

The category's 10.4% January gain suggests investors are in the mood for risk-taking

Jan 28, 2019 @ 12:52 pm

By Jeff Benjamin

Whatever investors were spooked by at the end of 2018, they seem to have shrugged it off so far this year.

Last year, the small-cap value funds category, as tracked by Morningstar, lost 15.5%, making it the worst-performing domestic equity fund category.

But so far this year, with the S&P 500 Index up 6.4%, small-cap value funds are leading the way with an average gain of 10.4%.

The four-week turnaround is reflective of a renewed risk-on mood among investors, said Todd Rosenbluth, director of mutual fund and ETF research at CFRA.

"The fact that it was the worst category last year has helped make it the best this year, because there is often a reversion back to the mean when environments shift back to risk-on," Mr. Rosenbluth said.

Category averages tell part of the story, but the swing is starker when you look at leaders like the $1.6 billion Invesco Small Cap Value Fund (VSMIX), which is already up more than 16% this year, after losing more than 25% last year.

Another example is the $33 million Schneider Small Cap Value Fund (SCMVX), which is up more than 17% in January, but lost nearly 33% last year.

Paul Schatz, president of Heritage Capital, called the leadership so far this year by small-cap value strategies "very unusual because growth usually leads during significant rallies."

The small-cap growth fund category is in second place behind small-cap value in January, with an average gain of 9.93%.

What's also illustrative of the turnaround in the markets since December is that even the worst-performing domestic-equity fund category, large-cap value, is up 6.4% so far in January.

For those who believe the fledgling market rally has some room to run and want to jump in, Morningstar analyst Russel Kinnel highlighted some favorites in the small-cap value space.

The $2.6 billion Janus Henderson Small Cap Value Fund (JSCVX) has a "long history of finding bargains in small value by emphasizing free cash flow and balance sheets rather than simply buying the cheapest of the cheap," Mr. Kinnel said. The fund is up 7.7% this month after losing 13.2% last year.

Mr. Kinnel also cited the $360 million LSV Small Cap Value Fund Investor Class (LVAQX), which is up 11.9% this year after losing 17.5% last year.

"To be sure, the fund takes it on the chin in bad years for small value, but that also means it has tremendous rebound potential," he said.

Finally, Mr. Kinnel gave a nod to the $1.3 billion Royce Special Equity Fund Investment Class (RYSEX), which offers a smoother ride, with a gain of 6.4% this month and a loss of 9.9% last year.

"Generally, this fund has held up nicely in bear markets," he said.

Mr. Schatz said investors should enjoy the ride but shouldn't get too aggressive in allocating to small-cap value.

"Keep in mind that value trailed growth for all of 2017 and 2018, except for a few short periods," he said. "I think it's too early to say whether this is just another blip of outperformance for small-cap value or the start of the real deal."


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