Investors are giving some stock pickers a chance

Published on NewsOK Modified: December 19, 2013 at 4:02 pm •  Published: December 19, 2013

NEW YORK (AP) — Stock pickers are getting respect again. Well, some of them.

Respect in investing often is measured in dollars, and investors this year have been putting money into some actively managed mutual funds. But only a select few: Funds that focus either on smaller-cap stocks or on stocks that look cheaper than the rest of the market have attracted new investment.

Otherwise, investors are continuing their yearslong migration toward index mutual funds. It's a trend called passive investing, and it's built on funds that aim to match the performance of a stock index, such as the Standard & Poor's 500, rather than try to beat it. Fans of passive investing say selecting which stock pickers will do well is tough enough to begin with, and index funds have lower expenses to boot. Through the end of November, U.S. stock funds run by stock pickers have lost $10 billion this year through investor withdrawals, according to Morningstar.

Managers of small- and mid-cap stock funds, though, say they have several advantages over others that give them a better chance to beat their benchmark indexes. Among them:

— The risks are higher in small-cap stocks. Of the companies in the small-cap Russell 2000 index, 25 percent don't make any money, says Nathan Moser. He is portfolio manager at the Pax World Small Cap fund (PXSCX), which has a five-star rating from Morningstar. Compare that with the large-cap S&P 500 index, where Moser says money losers make up only about 5 percent of the index.

A small-cap fund run by a stock picker can weed out those money-losing companies, focusing only on the profitable ones. The index fund, meanwhile, includes them all.

"If you're a passive investor, you're essentially saying you're going to take a low-quality approach to investing," Moser says. "While that may work over short periods of time, over the long term, you want to invest in quality."

— Fewer analysts and investors are paying attention to small-cap companies. CoStar Group is one of the largest companies in the Russell 2000 index with a market value of about $5 billion. It has six financial analysts who follow it, predicting its earnings and giving recommendations to investors.

Microsoft, in contrast, has a market value of about $300 billion, and it has 35 analysts tracking it. That means whenever Microsoft does something - whether it's developing a new product or reporting better-than-expected revenue growth - its stock price quickly reflects the news.

Because small- and mid-cap stocks get less attention, investors have a better chance of identifying stocks whose prices don't yet fully reflect the potential earnings growth of the company, says Brian Lazorishak. He is a portfolio manager at the Chase Mid Cap Growth fund (CHAMX). The fund's returns over the last 10 years rank in the top 25 percent of its category, according to Morningstar.

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