What are we looking for?
U.S. small/mid-cap funds to diversify U.S. market exposure.
The screen
The United States offers more attractive investment opportunities than Canada, especially when we consider the fact that Americans have higher productivity rates than Canadians. That said, the outsized performance of the “Magnificent Seven″ and the size of their global footprints beg the question of how much these companies truly represent our southern neighbors. That’s an important point given that their combined market cap makes up 28 per cent of the S&P 500 Total Return Index. So today I turn my attention to smaller companies in the U.S., which are less likely to run global operations (hence focusing an investor’s exposure to the U.S. market). Though investing individually in a small stock is inherently more risky than a large stock, investing in a basket of them through an investment fund creates diversification that offsets some of that risk. To provide ideas in this space, I use Morningstar Direct to screen for Canadian-domiciled mutual funds and ETFs in the U.S. small/mid-cap equity category that:
- Have received a Morningstar Rating for Funds (informally known as the “star” rating) of four or five stars. This rating is an objective look back at the risk-adjusted, after-fee performance of the fund, relative to its category peers. The rating considers the last 10 years of performance history, if available, and puts greater emphasis on recent performance history. Our data show that although the star ratings are backward-looking, funds that have received five stars as a group outperform those that have received four stars, three stars, etc., in periods after receiving the rating. In other words, it’s more likely that a fund manager with a track record of outperforming peers will continue to outperform in the future, as compared those that have historically underperformed peers.
- Have received a Morningstar Medalist Rating of gold, silver or bronze, highlighting funds that Morningstar believes will produce excess after-fee returns in the future, based on our analysis of people (quality of the management team), parent (stewardship of the fund company) and process (robustness of investment decision-making).
For consistency, only fee-based share classes of mutual funds were considered in the search, noting that the management expense ratios displayed do not include the fee that is charged by an adviser, separately, for advice and for managing your investments.
What we found
The funds that qualified in the screen are listed in the table accompanying this article alongside their management expense ratios, trailing performance, inception dates, ratings and the number of holdings in the portfolio. Readers will quickly notice that actively managed funds have a more concentrated portfolio exposure, given the portfolio managers’ conviction in their picks.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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Ian Tam, CFA