Investors who are lighter in small-company exposure than they would like can turn for ideas to Morningstar's short list of the best small-cap mutual funds and exchange-traded funds — those funds with at least one share class earning an analyst rating of Gold. On that list, investors will find both index funds and active managers. Passive strategies have several things going for them, Susan Dziubinski, director of content at Morningstar.com, wrote in a recent blog post. First is their cost advantage: All of Morningstar's Gold-rated passive funds carry below-average expense ratios, which gives them a lower hurdle to jump over to generate returns. Second, passive strategies tend to be more tax efficient than active strategies, which is a benefit for investors in taxable accounts. Third, passive strategies are less threatened by asset growth than active strategies. According to Dziubinski, the small-cap part of the market is an area where some active managers have been able to add value versus their respective indexes. But only three active funds on the short list are accepting money from new investors; the other actively managed funds on the list are closed to new investors. Dziubinski writes that it's no surprise that some of the actively managed Gold-rated funds are being closed. Why? Capacity is critical for many small-cap funds to maintain their approaches. The best small-cap funds close or otherwise limit new investment on occasion to keep their focus intact. The Gold-rated funds on Morningstar's list focus either on growth stocks or value stocks; none blends both styles. Dziubinski offers suggestions for investors who want broad-based exposure to small-company stocks from both the growth and value styles. One option, she writes, would be to combine one of the active or passive funds from the small-growth Morningstar Category with one of the active or passive options from the small-value category. Investors who prefer to invest in just one fund that covers the small-cap category, however, can delve into Silver- and Bronze-rated small-cap funds. Premium members of Morningstar.com can access a full list of all small-cap mutual fund medalists and ETF medalists. See the gallery for the 11 small-cap funds on Morningstar's short list.
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