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“Predictive” ETF & Mutual Fund Rating Methodology

Wednesday, November 23rd, 2011

QUESTION: Why shouldn’t ETF & fund research be as good as stock research? Why should fund investors rely on backward-looking NAV trends?

ANSWER: They should not.

QUESTION: Why has the traditional, backward-looking fund research dominated the dialogue on funds for so long?

ANSWER: Purveyors of the traditional fund research are extremely good marketers and nothing else has emerged to challenge them.

QUESTION: How exactly should fund research change to be more like stock research?

ANSWER: A fund is only as good as the stocks it holds. To rate a fund, one must research and rate all of its holdings while also accounting for management costs.

There are two dri­vers of future fund performance:

  1. Stock-picking (Portfolio Management Rating) and
  2. Fund expenses (Total Annual Costs Rating)

Our Predictive Overall Fund Rating is based on these drivers. Then, we rate all funds based on their ranking:

  1. Top 10%  = Very Attractive Rating
  2. Next 20% = Attractive Rating
  3. Next 40% = Neutral Rating
  4. Next 20% = Dangerous Rating
  5. Bottom 10% = Very Dangerous Rating

We analyze every fund holding based on New Constructs’ stock ratings, which are reg­u­larly fea­tured as among the best by Barron’s. Next, we measure and rank the all-in costs of investing in a fund (Total Annual Costs Rating).

Our free mutual fund & ETF screener provides ratings and reports on 7400+ funds updated daily.

Figure 1 details the criteria that drive our predictive rating system for funds. The two drivers of our predictive fund rating system are Portfolio Management and Total Annual Costs. The Portfolio Management Rating (details here) is the same as our Stock Rating (details here) except that we incorporate Asset Allocation (details here) in the Portfolio Management Rating. The Total Annual Costs Rating (details here) captures the all-in cost of being in a fund over a 3-yr holding period, the average holding period of all mutual fund investors.

Figure 1 – Predictive Overall Fund Rating Criteria and Thresholds for US Equity Funds

Source: New Constructs, LLC

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One Comment

  1. varadha says:

    Terrific, yet simple analysis. I’ve always been a fan of ROIC as a measure of capital efficiency and believe that no size/growth outperformance can replace the quest for efficiency.

    Sort of like a big gas guzzling v8 that needs ever increasing gallons of fuel to keep its engine running

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