Professionally-managed mutual funds occasionally suffer from a syndrome known as “style creep.” This occurs when a fund’s picks begin to drift from its target.
For instance, a manager might consciously select a “hot” stock that doesn’t quite fit the fund’s objectives in an attempt to boost the otherwise lackluster performance of the portfolio.
In other cases, a stock itself might change personalities. An equity may have been initially purchased because it ticked all the boxes as a growth stock, but after years of growth, the pace of growth slows, a dividend is paid and increased regularly, and the stock may now more accurately be considered a value stock.
It is also not unheard of for a company to transform itself by spinning off unit or acquiring a new firm that changes its primary business classification.
Market-cap-based funds face another type of creep that results from the growth of the selected companies. If a small-cap fund manager makes the right moves, the fund’s holdings will eventually outgrow the small-cap category. Some managers have a policy that allows them to keep companies that have outgrown their size classification as long as those companies still have good prospects. Others will weed out stocks that no longer meet their guidelines or exceed a certain threshold.
Individual investors can also experience a gradual upward drift in the size of companies in their portfolios, upsetting even the best-laid portfolio plans. If you have been following the SmallCap Informer for any part of the last decade, chances are that some of the picks chosen from the newsletter have grown considerably in size, and don't fit the "small" category any longer.
If so, it's a great time to take measure of your holdings, and make adjustments if necessary to meet your portfolio goals. We endorse BetterInvesting's recommendation that an individual investor's portfolio should ideally hold around 25% in small company stocks, 50% in midsized company stocks, and the rest in large-caps. If your portfolio is overloaded with larger companies, you will be pleased to know that there are an abundance of interesting, high-quality small-company stocks now available in this depressed market--companies that will serve long-term focused investors quite well, we expect.
A good tactic to utilize is the "challenge" concept. As you find new small companies of interest, consider them as challengers to larger companies in your portfolio, particularly if they are in the same or similar industries. In most cases the smaller companies provide a higher total return potential and be reasonable replacements--especially if your large-caps are tending towards the moribund.
Such is the case in this issue with our selection of a very small financial technology (“fintech”) stock that wins the head-to-head trial against a current holding that has outgrown our size classification.
Our first selection is a very small fintech company with an impressive customer list; as the company scales up, can more opportunities be coming their way? With a price that has fallen considerably in 2022, shares look inexpensive even if they don’t land another “whale” for a year or two.
Our second pick is a vital player in the e-commerce industry, but not necessarily because of its technological prowess. Without this company’s offerings, though, many retailers would find it hard to serve customers.
Stay the course!
Read the complete commentary and profiles of our two recommended small company stocks in the November 2022 issue of the SmallCap Informer stock newsletter.
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