Yahoo Finance

Banking on an improving U.S. economy, small-cap mutual funds are providing higher returns than large- and mid-cap ones. This is because small-cap funds are known for their higher domestic exposure than their large- and mid-cap counterparts. Hence, investing in these funds should lead to impressive returns against the current backdrop.

Outperforming Small-Cap Funds

According to Morningstar, small-cap funds clearly outperformed mid- and large-cap funds over the past one-month, three-month and year-to-date frames. While small-cap funds succeeded in providing average return of 3.2% over the last one-month period, mid- and large-cap funds managed to gain only 2.4%. Moreover, small-cap funds’ trailing three-month return of 8.2% clearly outpaced 5.8% and 4.4% gains of mid- and large-cap mutual funds.

Impressive returns have helped small-cap funds to register average return of 6.6% in the year-to-date frame. This is also higher than 5.8% and 4.2% returns posted by the mid- and large-cap alternatives. It is widely believed that an improving domestic economy and less international exposure supported the outperformance of the small-cap funds.

U.S. Economy Back on Track

June’s encouraging jobs report, ISM manufacturing and services indexes, and consumer spending data indicated that the U.S. economy is on a path of recovery after witnessing a sluggish first quarter. According to the U.S. Department of Labor, the economy saw healthy volume of 287,000 job additions in June after adding only 11,000 jobs in May. Moreover, the rejoining of 400,000 Americans led the unemployment rate to rise to 4.9% from 4.7% in May.

Moreover, manufacturing and services sectors are also experiencing impressive growth. While, the Institute for Supply Management (ISM) manufacturing index increased a 16-month high of 53.2% in June, ISM  Services  Index  advanced  to  56.5%,  witnessing its  best  rise  in the  last  seven  months. Out of 18 manufacturing industries, 12 reported growth leading the ISM Manufacturing Index higher.

Separately, the Federal Reserve reported that consumer credit increased $18.6 billion in May, well above April’s increase of 4.5%. It rose at an annual rate of 6.2%. Also, the Commerce Department reported that consumer spending rose 0.4% in May from April, preceded by a 1.1% rise in April, which was the highest gain in around seven years.

6 Small-Cap Mutual Funds to Buy

Given this encouraging scenario, we have highlighted two mutual funds each from three small-cap categories – value, growth and blend – that have a Zacks Mutual Fund Rank #1 (Strong Buy). We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund.