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First Trust Value Line 100 ETF (NYSEARCA:FVL) is in the Danger Zone this week. FVL is another example of a supposedly "passive" ETF that purportedly tracks an index but actually resembles an actively managed portfolio. FVL's methodology tracks an index, but it is an index in name only.

Anyone can create an index, and often the index is created specifically for the purpose of launching an ETF. FVL tracks the Value Line 100 Index. According to their website:

"The index is an equally-dollar weighted index that is designed to objectively identify and select 100 stocks from the universe of stocks to which Value Line assigns a #1 ranking in the Value Line Timeliness Ranking System."

It's unclear how exactly the selection is "objective" as the site claims. They tell you on the website that:

"The components of the Timeliness Ranking System, include factors such as the 10-year trend of relative earnings and prices, recent earnings and price changes, and earnings surprises."

That sounds to me like analyzing a variety of technical and fundamental data points to select stocks that you expect to outperform the market, a.k.a. active management. Even if the stocks are being selected based on a formulaic criteria, that's still a criteria created by humans. New Constructs puts out the Most Attractive and Most Dangerous stocks list every month based on our stock ratings. Even though those rankings are based on defined criteria, I would never describe them as an index the way Value Line is doing with their rankings system.

FVL does not hold an index, it holds a portfolio of stocks that, like any actively managed portfolio, is designed to out-perform the market. There's nothing inherently wrong with this. Actively managed portfolios can out-perform the market, even if most of them don't.

Unfortunately, FVL's holdings don't look likely to out-perform. 67% of its capital is in stocks with a Dangerous-or-worse rating. Only 12% of its assets are in Attractive-or-better rated stocks. Its holdings include recent Danger Zone picks Rite Aid (NYSE:RAD), Citigroup (NYSE:C), and Stein Mart (NASDAQ:SMRT). FVL's holdings get their worst scores on valuation.

Pilgrim's Pride Corp (NASDAQ:PPC) is another one of my least favorite holdings in FVL. PPC is not a bad company. Its return on invested capital (NASDAQ:ROIC) of 9% puts it near the median of all the companies we cover. The issue for PPC is its valuation. To justify its price of ~$17/share, PPC would need to grow after-tax profit (NOPAT) by 12% compounded annually. There is not a lot of value in this stock or this "value" index.

The final nail in the coffin for FVL is its high costs. Low fees are a major part of the appeal of index ETFs. As I mention in How To Avoid the Worst Style ETFs, the average total annual costs of the 223 style ETFs I cover, weighted by assets under management, is only 0.19%. FVL's TAC comes in at 0.70%. Those are not mutual fund level fees, but they are significantly higher than investors would pay for truly passive management.

As new ETFs come out of the woodwork every week, investors need to consider who these funds really serve. Value Line is leveraging its good brand name to try to make money selling an actively managed portfolio under the guise of an index. Investors who don't look closely at the fact sheet and the holdings could end up paying higher fees and not getting the type of exposure they expect.

Check out this week's Danger Zone Interview with Chuck Jaffe of Money Life and MarketWatch.com.

Sam McBride contributed to this report

Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: Danger Zone 8/27/13: First Trust Value Line 100 ETF