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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 price 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.

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).

Get access to New Constructs’ fund research. Or take a Virtual Tour and see all the benefits of our diligence.

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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3 Comments

  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

  2. David says:

    But Angie’s $90 per user acquisition cost is going to go away. That’s what their approach probably is. How would their outlook be if that $90 cost dropped down to a total cost of $3 per user?

  3. David:

    That would be great, but cost per user acquisition is not something that’s very easy for a company to fix. ANGI can slash their marketing budget to the bone, but then they would stop acquiring new members. They would probably lose members in fact, as their membership renewal rate is at ~75% and declining. If they cut marketing expense by ~95% as you seem to be suggesting, ANGI might be able to eke out 1 year of slight profits, but they would start shedding members and losing money very quickly. ANGI’s only hope is to keep its marketing budget high and hope it can reach the scale and brand awareness to be able to sustain its business while scaling back marketing costs enough to turn a profit. The fact that ANGI’s revenue growth is slowing down even as its marketing costs keep increasing makes it very unlikely it will achieve that goal.

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