What are we looking for?
Canadian-domiciled small-cap or mid-cap funds (SMID) and ETFs that have performed well despite a higher interest-rate environment
The screen
Many Canadians are likely breathing a sigh of relief following Wednesday’s interest-rate cut from the Bank of Canada, and it is also likely that CFOs are doing the same, given that lower interest rates mean companies can secure capital to fund growth at cheaper rates (albeit only slightly for now). For smaller companies, this has a big impact given that their capacity to borrow is much smaller than their large-cap counterparts. Though small caps are indeed riskier investments, their growth potential is also larger. Moreover, the recent market domination of the Magnificent Seven means many investors’ portfolios are likely less diversified than they were before the Magnificent Seven’s meteoric rise to the top. Hence, today we have a look at the small-cap fund space available to Canadian investors, for those who believe the era of high borrowing costs is on the way out, and for those who have the risk appetite to diversify beyond large- or mega-cap household names. To find ideas in this space, I used Morningstar Direct to screen for small- and mid-cap funds that:
- Have received a four- or five-star Morningstar Rating for Funds (also known as the “star” rating), indicating that the fund has historically outperformed respective category peers after fees, on a risk-adjusted basis;
- have received a Morningstar Medalist Rating of gold, silver or bronze, highlighting funds 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).
Only the oldest share class of each fund was considered in the search.
What we found
The funds and ETFs that qualified in the screen are listed in the table, alongside categories, MERs, trailing performance, inception dates, market cap exposure and ratings. The list is sorted first by category then by the star rating. Also denoted on the table is whether each fund or ETF is actively managed, passively managed or strategic/smart beta (which are funds that straddle the line between active/passive by using rules-based investing to provide consistent exposure to key investment factors such as value/growth/dividends/etc.) Though actively managed funds are indeed more expensive, they may be worthwhile considering in the small-cap space because of the inherent volatility built in to owning small companies. Most retail investors are likely ill-equipped to monitor a whole portfolio of small-cap names, which is where active management adds value. Investors are urged to first look at the category to which each fund belongs, given that Morningstar’s ratings are meant to measure performance against category peers.
This article does not constitute financial advice. It is always recommended to conduct one’s own independent research before buying or selling any of the funds or ETFs mentioned in this article.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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