Top-End Small Cap Fund Company Doing Well Overseas

Small Company Fund

Brown Capital Management’s Small Company Fund beats 99% of its peers. They also have a newer fund focused on foreign stocks that is getting accolades. Do they deserve them?

When you have a fund that has outperformed 99% of your peers over the last 15 years, that might be something to crow about. The use of the term peers here should at least raise an eyebrow though, especially when your peers are other small cap funds, as you may be the best of a lot that isn’t even worth bothering with, as small caps just haven’t been.

While small cap stocks both go down too much generally and don’t go up enough generally, this doesn’t mean that in theory anyway, someone could have been that good with their stock picks among this category to at least give a large cap index such as the Nasdaq at least a run for their money. If you can’t beat this index though, the only boasting that you’re entitled to do is to brag about how you beat some funds worse than you but still can’t compete with market averages.

If they can’t show us that they can do this, the only sensible thing to do is to just look away. If greener pastures are right before our eyes, some may want to close their eyes to this reality and seek out lesser performing investments, but we do not want to be among them. There are lots of people out there that are taken by whatever appeal lesser performing stock types may have for them though, but it always needs to come down to relative performance since that’s how we keep score whether we pay attention to the score or not.

The argument for this cashes out to wanting to take someone who has won a gold medal in the Special Olympics and thinking that they can compete in the Olympics. All they look at is the color of the medal and don’t even look at lap times compared to the world’s best, but if you don’t, you can indeed fool yourself it seems.

The demand for Brown’s flagship fund was so high at one time that they had to close it off to new investors, which does tell us that there is certainly a good-sized market for this sort of thing. Not wanting to miss out on this interest though, they started a new fund in 2015, focusing on small caps as well, but this time focusing on foreign stocks.

That’s two big strikes against a fund though, as small caps underperform generally, and foreign stocks also underperform generally, so beating the market with something like this is especially challenging. Brown obviously likes a challenge, and people are speaking about how this new fund is “crushing” its peers in the foreign stock category, which once again doesn’t mean very much in itself.

We do need to have a look at how these funds are actually doing though, and not just buy the accolades which only point to these funds being big fishes in small ponds. We need to know how they stack up in the big pond though against much bigger fish, to see just how well this David is actually doing this time against Goliath.

Why the fact that these funds beats small cap funds or international stock funds even matters to anyone is pretty curious actually. The funds themselves are going to want to blow their horns over these things, but the fact that people are listening to this music and finding it appealing enough to not even want to do much comparing against other competition is pretty bizarre, but all sorts of bizarre things go on in the world of investing so this is not out of character at all.

We will start by looking at their main small cap fund and then move on to this newer, internationally focused small cap fund. The first thing that we need to look at is how these funds have done lately, as it might be nice to say that a small-cap fund has beaten 99% of its peers over the last 15 years, but 15 years is a long time, and what it’s done lately needs to matter as well.

Brown Capital Management Small Company Fund hasn’t done that badly from a nominal perspective over the last 5 years, with a return of 48% over this time. The Nasdaq has risen 110% over this time though, and Brown taking a beating this bad is more than enough to declare it well defeated.

Getting Less Upside and More Downside is Just a Recipe for Failure

This well reveals the characteristic of small cap funds having a much less powerful engine under the hood than large caps, it’s smaller return in other words, but there’s also the fact that their brakes don’t work as well, the risk side.

Brown’s flagship fund gave up 38% between September and December of 2018, where the Nasdaq, famous for its volatility, only gave back 21% over this time. When we put the two together, the tendency for small caps to go up less and go down more, we end up with Brown still being off 14% since September 2018, while the Nasdaq is up 21% since then. Brown Capital isn’t crushing with this fund, they are instead being crushed.

We don’t need to go any further, but the fund only getting a 19% return in 2019, half that of the Nasdaq, further speaks to its present undesirability. This included a 13% drop in the first 2 weeks of last December, where it once again showed us how unstable it is, and even though they made a modest half-share of gains in 2019, they are barely up over the last 12 months and have spent it bouncing up and down like a yo-yo with no clear direction.

If this is their star performer, it is one that may have won a singing contest at a local bar and might even be the best performer in town, and if you don’t listen to music on the radio you might even think that they are the best ever, but for them to be any good at all you need to listen to the music made outside your town. This ends up being a crappy song indeed when we step out into the bigger world and compare.

The best we can say about this fund is that the world may have been made a better place when they stopped taking new investors, although anyone clamoring at the bit to get in on this just does not know what they are doing and they will very likely pick something as bad or worse instead. This is a terribly performing fund overall these days though, and even though some investors may want to pretend that we don’t need to expose it to the real light of day and just keep it in the small-cap closet, only a fool would do such a thing.

Some may claim that small-caps will have their day someday, but that day isn’t today, and this is not something that you want to just take a lark with. There isn’t even a good reason to believe this, but even if there was, we’d still need to see it happening before we could say that their day has finally arrived where they can at least compete with big cap growth funds, who slaughter them even more than the Nasdaq average does.

The same is true with international stocks, where some people think that U.S. stocks are extended and international stocks will start taking over soon. This is another lark, and one that has no basis in the real world right now, and when you put two larks together in one fund, we may need to brace ourselves.

Having a look at the chart of the Brown Capital Management International Small Company Fund reveals that it is at least performing better than their regular Small Company Fund, which is impressive considering the additional challenges. This fund has been around for a little less than 4 ½ years, but has returned 82% in total since then.

That’s still not good enough to quite get them in the big leagues, as the Nasdaq has moved up by 100% over these 4 ½ years, and the goal here is to at least beat the averages before you can even pretend to claim to be better. If and only if they can do this, do they earn a spot taking on against the big gorilla in the room, the SPDR tech fund, which is up 148% over this time.

When you get beaten by chimps who just sit back and watch their positions in index funds with no knowledge or skill whatsoever, this is not something you should be willing to share with anyone. When you don’t even share this insight with yourself though, you are in trouble indeed.

The international version of this is at least up 4% from their 2018 high, instead of being down 14% as their domestic small cap fund is. Still though, that’s a pretty paltry return for a year and a half in a stock environment this bullish, and is embarrassing low compared to even market averages let alone funds that are put together for above average performance.

A lot of funds don’t beat the market averages, but when you don’t either but still feel entitled to boast about your performance, something is seriously wrong with your thinking. When this even manages to escape the attention of a lot of people, this is like picking a door with goats behind it in the Let’s Make a Deal show and being happy you won the goats because you didn’t know there are better prizes.

Why Would Anyone Want to Be in Small Caps Right Now?

This may give some credence to the fact that international small cap stocks may not be as bad as U.S. ones, even though international stocks in general pale in comparison to U.S. ones, but why we would ever want to invest in any small cap fund is left completely unexplained. This certainly isn’t a reason to want to be in this fund, unless you are possessed with the strange idea that we should only be looking at small caps.

When we read articles on funds like this, and see them only compare funds within categories, to a degree that leaves us wondering if they are just looking to pump them up. This international fund is also touted as beating its peers, although why anyone would want to limit themselves to comparing with just these peers is left unconsidered. We’re left to guess though and this may very well just be a matter of ignorance, not getting beyond the question of whether it’s a good idea to buy any fund in the category.

Even if small caps were the rage and were beating everything else out there, we never want to confine our view to just one type like this and still need to keep looking around and evaluating. It is not that small caps are in any sense defensive, like the SPDR utilities index is for instance, which we may make sense of a fund having a weaker offense because it plays defense better. Small caps play a weaker defense than even the Nasdaq does, and we therefore need more upside to justify this, not a lot less.

The SPDR utilities ETF is the standard for defense, and people gladly accept lower returns to benefit from this. If this sector fund is both providing much better protection than this international small cap fund and is also producing more upside, this would simply be shameful.

Over the last 2 years, Brown’s international small company fund has delivered a total return of 15%. The SPDR utilities fund has moved up by 40% over the last 2 years, not only beating Brown’s fund, but embarrassing them, if anyone cared to look that is.

You don’t get embarrassed when you sing in the shower though, and your wife or husband may think that you are pretty good as long as no one compares you to professional singers. Seeing these funds compared to their peers may even serve their purpose of getting some investors excited and run out and buy some shares of it, but if this is your threshold of diligence, you deserve to see your portfolios underperform.

There are some who think that we should include small-cap funds in our portfolio to provide diversity, and they are so taken with this task that they don’t realize that when you add something in, it has to have some sort of benefit to us, like diversifying with utilities does by providing a hedge against risk. When you flunk out on both return and risk, you just flunk period, and we must resist the temptation to be so dim as to want something like this on purpose.

We never should want to be dumped off on desert islands to be left to wait for our ship to come in. It may never arrive, and meantime we’re left for a harder life as a result of our strange choice, while those on the mainland prosper. We need to just say no to this idea, and should only be willing to invest in either of these funds of Brown’s at gunpoint, although to be fair, the same could be said of a lot of other funds out there.

Being tricked into thinking a fund is a good one just because it beats a bunch of bad ones shows how low the bar is for many investors, who just swallow stories like this whole without thinking at all. With our futures on the line, we cannot afford to be led around blindly like this.

The fact that a simple question such as how this fund does outside the small cap arena ends up leveling the idea shows how blind some investors and some market commentators are. The blindfold is on pretty tight it seems, for reasons no one really knows nor cares to even wonder about. The first and most critical step we need to make is to lose our blindfold and at least start looking past a bunch of hype that does not survive a single glance when the light it shines hits our eyes.

Investing isn’t that hard, but it sure is trying to do it blindfolded.

Andrew Liu


Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.