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Best & Worst ETFs and Mutual Funds: Small-cap Value Style

Monday, October 22nd, 2012

The small-cap value style ranks last out of the twelve fund styles as detailed in my style rankings for ETFs and mutual funds. It gets my Dangerous rating, which is based on aggregation of ratings of 13 ETFs and 263 mutual funds in the small-cap value style as of October 22, 2012. Prior reports on the best & worst ETFs and mutual funds in every sector and style are here.

Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the style. Not all small-cap value style ETFs and mutual funds are created the same. The number of holdings varies widely (from 18 to 1684), which creates drastically different investment implications and ratings. The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst, which allocate too much value to Neutral-or-worse-rated stocks.

To identify the best and avoid the worst ETFs and mutual funds within the small-cap value style, investors need a predictive rating based on (1) stocks ratings of the holdings and (2) the all-in expenses of each ETF and mutual fund. Investors need not rely on backward-looking ratings. My fund rating methodology is detailed here.

Investors should not buy any small-cap value ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this style, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off.

Get my ratings on all ETFs and mutual funds in this style on my free mutual fund and ETF screener.

Figure 1: ETFs with the Best & Worst Ratings – Top 5

* Best ETFs exclude ETFs with  NAVs less than 100 million.

Sources: New Constructs, LLC and company filings

Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5

* Best mutual funds exclude funds with NAVs less than 100 million.

Sources: New Constructs, LLC and company filings

WisdomTree SmallCap Earnings Fund (EES) is my top-rated small-cap value ETF and Allianz Funds: NFJ Small-Cap Value Fund (PSVIX) is my top-rated small-cap value mutual fund. Both earn my Neutral rating.

Rydex S&P Smallcap 600 Pure Value (RZV) is my worst-rated small-cap value ETF and earns my Dangerous rating. Touchstone Strategic Trust: Touchstone Micro Cap Value Fund (MXCAX) is my worst-rated small-cap value mutual fund and earns my Very Dangerous rating.

Figure 3 shows that 421 out of the 2218 stocks (over 23% of the total net assets) held by small-cap value ETFs and mutual funds get an Attractive-or-better rating. However, none of the 13 small-cap value ETFs and none of the 263 small-cap value mutual funds get an Attractive-or-better rating.

The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and small-cap value ETFs hold poor quality stocks.

Figure 3: Small-cap Value Style Landscape For ETFs, Mutual Funds & Stocks

Sources: New Constructs, LLC and company filings

As detailed in “Cheap Funds Dupe Investors”, the fund industry offers many cheap funds but very few funds with high-quality stocks, or with what I call good portfolio management.

Investors need to tread carefully when considering small-cap value ETFs and mutual funds, as no ETFs or mutual funds in the small-cap value style allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating. Focus on individual stocks instead.

Harman International Industries, Inc. (HAR) is one of my favorite stocks held by small-cap value ETFs and mutual funds and earns my Very Attractive rating. HAR has positive and rising economic earnings, a truer measure of profitability than reported earnings. HAR’s current stock price of ~$43.78 implies that the company’s NOPAT will permanently decline by 7%, a low hurdle for a company with a return on invested capital (ROIC) of 15%. Strong performance combined with a cheap valuation makes HAR an Attractive stock.

Teleflex Inc. (TFX) is one of my least favorite stocks held by small-cap value ETFs and mutual funds and earns my Dangerous rating. TFX is a value destroyer that has generated positive economic earnings in just two of the last 10 years. Not only has TFX destroyed shareholder value, but it also has misleading earnings – reported earnings are positive and increasing while economic earnings are negative and declining. Investor’s who don’t do their due diligence and read the financial footnotes and MD&A may be in for a not-so-nice surprise.

Figures 4 and 5 show the rating landscape of all small-cap value ETFs and mutual funds.

Our style rankings for ETFs and mutual funds report ranks all styles and highlights those that offer the best investments.

Figure 4: Separating the Best ETFs From the Worst Funds

Sources: New Constructs, LLC and company filings

Figure 5: Separating the Best Mutual Funds From the Worst Funds

Sources: New Constructs, LLC and company filings

Review my full list of ratings and rankings along with reports on all 13 ETFs and 263 mutual funds in the small-cap value style.

Disclosure: I receive no compensation to write about any specific stock, sector, style or theme.

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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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