Micro-cap funds may present an opportunity

Many are trading below book value

By David Hoffman May 12, 2008, 6:01 AM EST Post a Comment Recommend

Micro-cap stocks are beaten down to the point where the mutual funds that invest in them are starting to see new opportunities.

It's the reason the $95 million Wasatch Micro Cap Value Fund (WAMVX), and $47 million Wasatch International Opportunities Fund (WAIOX), both advised by Wasatch Advisors Inc. of Salt Lake City, reopened to new investors May 1.

"With the Russell Microcap Index down nearly 21% over the past 12 months we are finding so many interesting buy opportunities that we would love to be able to bring in a few new shareholders at this point of the market cycle," said Brian Bythrow, a manager of the Wasatch Micro Cap Value Fund.

Micro-cap stocks — generally defined as those with capitalization under $250 million — could get cheaper, but with so many trading below book value it's a good time to buy, he said.

That's a reasonable assumption, said Russell Wild, principal of Global Portfolios, an Allentown, Pa., financial advisory company that works on an hourly basis and does not manage assets.

"If you're a buy-and-hold investor ... and you're looking to capture gains over the long run, then buying a beaten-down sector makes sense," he said.

BUYER BEWARE

However, investors need to be extra careful when it comes to micro-caps, said Mr. Wild, a proponent of micro-cap investing who believes the sector offers a high potential return, but come with "commensurate volatility."

That's because micro-cap stocks are "far less liquid" than the market in general, said Jeff Tjornehoj, a Denver-based senior analyst with Lipper Inc. of New York.

Limited liquidity is a problem that few asset managers are willing to take on.

There are only 47 funds that invest specifically in micro-cap stocks, many of which are closed to new investors, compared to 552 funds that invest in small-cap stocks, according to Lipper.

Small-cap stocks generally have capitalizations between $250 million and $2 billion.

In many cases, investors not willing to take the risk of investing in micro-caps would do better sticking with small-cap funds, Mr. Tjornehoj suggested.

"You may find there are periods where micro-caps are less correlated to the broader stock market, but they are still going to correlate with small-cap stocks," he said.

That can be seen in the average performance of micro-cap and small-cap funds.

Over the 12 months that ended April 30, micro-cap funds finished down 17.11%, but they were up 5.79% for the annualized three-year period, and up 12.96% for the annualized five-year period, according to Lipper.

Small-cap funds ended down 10.06% for the year, but were up 8.36% for the annualized three-year period, and up 13.35% for the annualized five-year period, according to Lipper.

Some micro-cap funds did better than others.

For example, ending April 30, the Wasatch Micro Cap Value Fund was down 12.27% for the year, but was up 13.26% for the annualized three-year period, according to Lipper. Launched in July 2003, the fund has yet to establish a five-year track record.

The $902 million Royce Micro-Cap Fund (RYOTX), which reopened to new investors in January, has an even better track record.

Ending April 30, the fund, which is advised by Royce & Associates LLC of New York, was down 6.87% for the year, up 14.85% for the annualized three-year period, and up 19.17% for the annualized five-year period, according to Lipper.

Only one other micro-cap fund — the $591 million Turner Emerging Growth Fund (TMCGX), which is advised by Turner Investment Partners Inc. of Berwyn, Pa. — had a better long-term track record.

Ending April 30, the fund was up 0.26% for the year, up 14.28% for the annualized three-year period, and up 19.75% for the annualized five-year period, according to Lipper.

The fund is currently closed to new investors.

BIG EXPENSES

Investors need to keep in mind that most micro-cap funds suffer from high expenses, Mr. Tjornehoj said.

The average asset-weighted expense ratio for investors in mutual funds last year was 0.9%, according to Morningstar Inc. of Chicago.

The Turner micro-cap fund's expense ratio is 1.40%, and the Royce micro-cap fund's expense ratio is 1.46%, according to Morningstar.

Both reopened Wasatch micro-cap funds have ratios of 2.25%, according to Morningstar.

"That's pretty hefty," Mr. Wild said.