In addition to investing in micro-cap companies, investors have the option to invest in Micro-cap mutual funds, and there are many of these funds in the market. Just as there are many options in mid-cap, large-cap, and macro-cap funds, there are many options for Micro-cap funds as well. These funds can be purchased by individual investors and are also a part of many retirement plans such as 401Ks and IRAs.
Investing in small and micro-cap companies involves additional risks, as there may be greater fluctuations in value and less liquidity than larger companies. You should know that some funds also invest in foreign securities, which involve greater volatility and economic and currency risks, along with different accounting methods. However, according to Peter Sidoti in an article at Thestreet.com “Small and micro-cap stocks have often gotten an unfair reputation as being too risky or too volatile for many investors. The truth is, however, we believe those who write off these asset classes out on solid earnings potential from some of the healthiest companies in America.” The bottom line is that even though these smaller stocks are more volatile than large-cap stocks, there is more opportunity for big returns.
Just last year, micro-caps were on the list as top-performing funds. For example, at the end of 2013, USA Today announced that the Managers AMG Essex Small/Micro-cap fund was the top performer among micro-cap funds, soaring 59.5% in 2013 alone. Their runner-up was the Oberweis Micro-cap fund, up 59.1% in 2013. When compared to the average U.S. mutual fund gain of 31.8% for 2013, the micro-caps performed extremely well, almost doubling the average mutual fund’s performance.
Typically, fund managers are selecting smaller, undiscovered companies poised for growth and earnings, which offers shareholders some protections from market fluctuations. They are selecting little known companies with statistically cheap stock prices, where the stock’s perceived value is low based on the company’s growth and performance. Since these stocks may have been neglected by many institutional investors, these funds may be able to provide higher returns and higher capital appreciation.
Think Apple in the late 1970s. It was once a micro-cap stock and now trades at over $500 per share. There’s also Yahoo, Microsoft, and countless others that were once micro-cap stocks but are now large-cap or macro-cap stocks. They were once on the radar of savvy institutional investors and fund managers and those that invested early with these companies and held on have done extremely well. These companies were once unknown names to the majority, but now they are household names.
Just as mid-cap or large-cap funds have a diversified portfolio, microcap funds are diversified as well. Here is a list of many of the sectors which you will see in a typical micro-cap fund:
Industrials
Financial
Services
Healthcare
Technology
Energy
Materials
Utilities
Consumer Staples
Durable Goods
Consumer Discretionary
Telecommunications
Fund diversification is important because various sectors and companies may increase or decrease due to market or economic conditions during a given time period, so this may help to minimize the volatility and risk associated with investing in a fund rather than a single stock.
There are a lot of great micro-cap funds out there that have a great record of performance. We will discuss some of these companies in future articles. If you would like to add these to your investment portfolio, do your due diligence, which involves evaluating the fund’s past performance, current performance, market conditions, fund management, and fees.