Spare a thought for small-cap Australian equity funds.
Global risk aversion, the sell-off in resource stocks and heavy falls in micro-cap stocks provide a terrible backdrop for small-cap funds. Yet, this managed funds segment continues to deliver better relative performance than most fund groups.
Investment research house Morningstar's latest managed funds performance summary shows that on an absolute basis, small-cap equity funds fell 10.92 per cent on average in the second quarter of 2012.
That beat a 15.3 per cent fall in the S&P/ASX Small Ordinaries Index, but was still a painful loss for investors.
"Small-cap Australian share funds fell victim to the 'risk-off' trade that gripped markets for much of the quarter," Morningstar said.
Most fund managers struggled in the second quarter, with those managing local and global property funds the exception as the average Australian listed property fund returned 8.36 per cent in the quarter.
Morningstar said: "The majority of large-cap Australian and international share funds lagged their relevant market benchmarks, and many bond fund managers got caught with relatively short-duration positions while yields fell. The major exception was small-cap funds."
It found 43 of 46 small-cap managed funds outperformed their benchmark Small Ordinaries Index in the second quarter - an encouraging relative result given the high volatility in the sector.
Large falls in the small resources component of the Small Ords may have helped the small-cap funds category, given many funds have low exposure to speculative exploration companies, or gain leverage to the resources sector through more established, profitable mining services companies.
In contrast, only 38 of 100 large-cap Australian share funds outperformed the S&P/ASX 300 Accumulation Index over the second quarter.
On an absolute basis, large-cap funds performed better than small-cap funds. Australian large-cap value funds lost an average 4.34 per cent and large-growth funds shed 6.34 per cent.
SmallCo Investment Fund was the best performer in the small-cap segment and the only one to deliver a positive return in the second quarter, up 4.81 per cent.
By mostly excluding resource stocks, SmallCo had a buffer against a 26 per cent fall in small-cap resource stocks during the quarter.
Among other small-cap managed funds, Hyperion Small Growth Companies and Aberdeen Australian Small Companies posted small quarterly losses because they too had less exposure to resources.
With $65 million in net assets, SmallCo is now the best-performing small-cap fund over one and three years, although among the worst performers over five years.
The fund's low exposure to emerging resource stocks hurt returns when the small-cap resource sector boomed in 2010, and helped the fund outperform amid the heavy sell-off in speculative mining stocks in the past 12 months.
Leading small-cap equity funds have struggled over one year.
The Ausbil Australian Emerging Leaders Fund, the sector's largest with $723 million in net assets, has shed 16.09 per cent over one year and is ranked last of 46 funds.
The Eley Griffiths Group Small Companies Fund, with $475 million in net assets, lost 6.33 per cent over one year to rank 27th in its category over that period. The Pengana Companies Fund lost almost 5 per cent over one year, and ranked 18th.
Like most small-cap funds, Eley Griffiths and Pengana still outperformed the Small Ords.
Heavy absolute losses in the sector will not please investors, or the funds themselves, although higher volatility in returns is inevitable in small-cap investing compared with large-cap investing.
But at least investors know small-cap fund managers are earning their fees by outperforming their index.
The continued poor average relative performance of large-cap growth funds, compared with their benchmark index, adds weight to the argument that investors can gain low-cost exposure to large-cap stocks using index funds, and choose small-cap funds to add more outperformance to portfolios.
