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16 July 2013

Best & Worst ETFs and Mutual Funds: Large Cap Blend Style

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The Large Cap Blend style ranks first out of the twelve fund styles as detailed in my Style Rankings for ETFs and Mutual Funds report. It gets my Neutral rating, which is based on aggregation of ratings of 31 ETFs and 955 mutual funds in the Large Cap Blend style as of July 11, 2013. 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 Large Cap Blend style ETFs and mutual funds are created the same. The number of holdings varies widely (from 17 to 1004), 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 Large Cap Blend 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 seeking exposure to the Large Cap Blend style should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2.

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

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* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

First Trust Mega Cap AlphaDEX Fund (FMK), iShares Russell Top 200 ETF (IWL) and ProShares UltraPro Dow30 (UDOW) is excluded from Figure 1 because its total net assets (TNA) are below $100 million and do not meet our liquidity standards.

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

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* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Guggenheim Russell Top 50 ETF (XLG) is my top-rated Large Cap Blend ETF and SunAmerica Focused Dividend Strategy Portfolio (FDSWX) is my top-rated Large Cap Blend mutual fund. XLG gets my Attractive rating, and FDSWX earns my Very Attractive rating.

ALPS/GS Risk-Adjusted Return U.S. Large Cap Index ETF (GSRA) is my worst-rated Large Cap Blend ETF, and Advisors Series Trust Orinda SkyView Macro Opportunities Fund (OMOAX) is my worst-rated Large Cap Blend mutual fund. GSRA earns my Dangerous rating, while OMOAX gets my Very Dangerous rating.

Figure 3 shows that 299 out of the 1512 stocks (over 37% of the market value) in Large Cap Blend ETFs and mutual funds get an Attractive-or-better rating. However, only 4 out of 31 Large Cap Blend ETFs (less than 1% of total net assets) and 51 out of 955 Large Cap Blend mutual funds (less than 4% of total net assets) get an Attractive-or-better rating.

The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and Large Cap Blend ETFs hold poor quality stocks.

Figure 3: Large Cap Blend Style Landscape For ETFs, Mutual Funds & Stocks

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Sources: New Constructs, LLC and company filings

As detailed in “Low-Cost 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 Large Cap Blend ETFs and mutual funds, as only a handful out of almost 1000 funds hold enough good stocks to qualify as Attractive or Very Attractive. 4 ETFs and 51 mutual funds in the Large Cap Blend style allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating.

Chevron (CVX) is one of my favorite stocks held by Large Cap Blend ETFs and mutual funds and earns my Attractive rating. Since 1998, Chevron has increased its after-tax profit (NOPAT) by an impressive 23% compounded annually, all while raising its return on invested capital (ROIC) from 4% to 11%. This is the mark of a well-managed company: the ability to rapidly grow while increasing the efficiency with which capital is used. CVX has also increased its economic earnings from $3.1 billion in 2004 to $8.4 billion today. By all metrics, CVX has been rising rapidly, but the market seems not to have noticed this, as CVS is currently trading at the cheap price of ~$123.40/share. This price gives CVX a price to economic book value ratio of 0.8, which means that the market expects CVX’s profits to permanently decline by 20%. Looking at CVX’s history of rapid profit growth and effective capital management, this looks unlikely. The stock is trading at a discount right now and investors should take advantage before the market catches up.

Southwestern Energy (SWN) is one of my least favorite stocks held by Large Cap Blend ETFs and mutual funds and earns my Dangerous rating. SWN’s profits (NOPAT) have fallen by 2% compounded annually since 2008, and it has a return on invested capital (ROIC) of 6.5%, down from 16% in 2008. SWN also has accumulated asset-write downs of over $1.8 billion (37% of net assets), a sign that management is destroying value for investors. The main reason investors should avoid SWN, however, is because it is too expensive. SWN currently trades at ~$38.53/share. To justify this price, SWN would need to grow NOPAT by 8% compounded annually for the next 8 years. Investors should look for better-managed companies with cheaper valuations than SWN.

Figures 4 and 5 show the rating landscape of all Large Cap Blend ETFs and mutual funds.

My 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

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Sources: New Constructs, LLC and company filings

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

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Sources: New Constructs, LLC and company filings

Review my full list of ratings and rankings along with reports on all 31 ETFs and 955 mutual funds in the Large Cap Blend style.

André Rouillard and Sam McBride contributed to this report.

Disclosure: David Trainer owns CVX. David Trainer, André Rouillard and Sam McBride receive no compensation to write about any specific stock, sector, style or theme.

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