Best And Worst Funds: Industrials Sector

by: David Trainer

The Indus­tri­als sec­tor ranks sixth out of the ten major sec­tors as detailed in our sec­tor roadmap. It gets my Neu­tral rat­ing, which, like my fund rat­ings, is based on aggre­ga­tion of stock rat­ings for each of 430+ com­pa­nies in the sector.

Indus­tri­als stocks are likely to pro­vide lack­lus­ter returns over the com­ing years given the dour eco­nomic out­look for global growth. The con­tin­ued shift away from tra­di­tional indus­trial man­u­fac­tur­ing toward more sophis­ti­cated man­u­fac­tur­ing for more com­plex prod­ucts like mobile phones means some indus­trial com­pa­nies will per­ish while some are reborn. There will be few good Indus­tri­als stocks.

There are fewer good Indus­tri­als funds. Fig­ure 1 shows that pick­ing the right mutual fund or ETF in the Indus­tri­als sec­tor is more dif­fi­cult than pick­ing stocks in the sec­tor. While over 20% of the mar­ket value of Indus­tri­als stocks gets my Attractive-or-better rat­ing, none of the 35 sec­tor funds score as well.

Port­fo­lio man­agers of funds in this sec­tor are not doing a good job of select­ing the best stocks in the sec­tor. Investors should avoid funds in this sec­tor because the cost of port­fo­lio man­age­ment (active or pas­sive) is not jus­ti­fied. The best sec­tors for find­ing funds and stocks are Tech­nol­ogy and Con­sumer Sta­ples. My series of Best & Worst Funds reports on all sec­tors is under my profile.

Fig­ure 1: Indus­tri­als Sec­tor Land­scape For Funds & Stocks

Sources: New Con­structs, LLC and com­pany filings

If you are forced to choose a fund in the Indus­tri­als sec­tor, know that all 35 funds are very dif­fer­ent. Per Fig­ure 2, the num­ber of hold­ing varies widely (from 20 to 369), which cre­ates dras­ti­cally dif­fer­ent invest­ment impli­ca­tions and rat­ings. Here is the full list of 35 funds.

How do investors pick the right fund out of the sea of choices that will deliver the best returns?

Fig­ure 2: Funds with Most & Least Hold­ings - Top 5

Sources: New Con­structs, LLC and com­pany filings

To iden­tify the best funds within a given cat­e­gory, investors need a pre­dic­tive rat­ing based on analy­sis of the under­ly­ing qual­ity of stocks in each fund. See Figure 2.

Our pre­dic­tive fund rat­ings are based on aggre­gat­ing our stock rat­ings on each of the fund's hold­ings and all of the fund's expenses. Investors deserve forward-looking fund research that is com­pa­ra­ble in qual­ity to stock research.

Investors should not rely on backward-looking research of past per­for­mance for invest­ment decisions.

Fig­ure 3 shows the five best and worst-rated funds for the sec­tor. Every fund in the sec­tor over weights Neutral-or-worse rated stocks. Despite hav­ing lower allo­ca­tions to Dangerous-or-worse-rated stocks, two classes of Rydex Series Funds: Trans­porta­tion Fund RYNCX [RYNCX] and RYTSX [RYTSX] receive my Very Dan­ger­ous rat­ing because their total annual costs are a whop­ping 5.01% and 5.98%.

One of my favorite stocks in the Indus­tri­als sec­tor is 3M Com­pany (NYSE:MMM), which gets my Very Attrac­tive rat­ing. This com­pany is an excel­lent exam­ple of an Indus­trial com­pany that has posi­tioned itself as a leader in sophis­ti­cated man­u­fac­tur­ing. 3M con­sid­ers itself a Tech­nol­ogy, not an Indus­trial, com­pany. That mind­set is required to stay abreast of the con­stantly shift­ing land­scape of tech­no­log­i­cal inno­va­tion and man­u­fac­tur­ing of the prod­ucts cre­ated by that inno­va­tion. With an ROIC of 18%, 3M gen­er­ates prof­its like a Tech­nol­ogy com­pany. And like all my Very Attractive-rated stocks, it has a cheap val­u­a­tion. The cur­rent stock price (~$86.70/share) implies the com­pany will not grow its prof­its more than 10% over the remain­der of its cor­po­rate life. That seems a bit pes­simistic for a com­pany sup­ply­ing key com­po­nents to fast grow­ing mobile phone and com­puter firms like Apple. The fund that allo­cates the most assets to MMM is Indus­trial Select Sec­tor SPDR (NYSEARCA:XLI). How­ever, I do not rec­om­mend investors buy XLI because it gets my Neu­tral rat­ing due to the fact that it allo­cates too much of the rest of its assets to Neutral-or-worse rated stocks. Per above, there are a few good stocks in the Indus­tri­als sec­tor but no good funds.

One of my least favorite Indus­tri­als stocks is Tex­tron (NYSE:TXT), which gets my Very Dan­ger­ous rat­ing. Stuck in tra­di­tional Indus­trial activ­i­ties like aero­space and defense, Tex­tron is the oppo­site of 3M in many ways. First, Tex­tron focuses pri­mar­ily on tra­di­tional man­u­fac­tur­ing of com­mer­cial and defense air­craft and auto­mo­biles. It also has a finance divi­sion and makes golf carts. Not a lot of focus here. Given expec­ta­tions for cuts in spend­ing of one of TXT's largest cus­tomers, the US Defense Depart­ment, it is fair to say that growth prospects for TXT are not bright. How­ever, the stock's val­u­a­tion tells another story. To jus­tify its cur­rent stock price (~$25.48), the com­pany must grow its prof­its (NOPAT) at over 15% for 20 years com­pounded annu­ally. It is hard to believe that is pos­si­ble for a com­pany with TXT's prospects and his­tor­i­cal growth at a frac­tion of that level. I also rec­om­mend investors avoid SPDR S&P Aero­space & Defense ETF (NYSEARCA:XAR), which gets my Dan­ger­ous rat­ing and has TXT as its largest holding.

Fig­ure 3: Funds with the Best & Worst Rat­ings - Top 5

* MF des­ig­nates Mutual Funds and ETF des­ig­nates Exchange-Traded Funds

Sources: New Con­structs, LLC and com­pany filings

Investors should not buy any Mate­ri­als funds. None of the 35 funds allo­cate enough value to Attractive-or-better-rated stocks to earn an Attrac­tive over­all rat­ing. Fig­ure 4 charts the rat­ing land­scape of all ETFs and mutual funds in the Indus­tri­als sector.

Our Sec­tor Roadmap report ranks all sec­tors and high­lights those that offer the best investments.

Fig­ure 4: Sep­a­rat­ing the Best Funds From the Worst

(Click to enlarge)

Sources: New Con­structs, LLC and com­pany filings

Fig­ure 5 lists our Pre­dic­tive Fund Rat­ing for the 5 largest and most pop­u­lar Indus­tri­als funds.

Fig­ure 5: Five Largest Indus­tri­als Funds

* MF des­ig­nates Mutual Funds and ETF des­ig­nates Exchange-Traded Funds

* Analy­sis uses the top-ranked class for each fund

Sources: New Con­structs, LLC and com­pany filings

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.