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The best funds have high-quality hold­ings and low costs. As detailed in "Cheap Funds Dupe Investors," there are few funds that have both good hold­ings and low costs. While there are lots of cheap funds, there are very few with high-quality holdings.

With­out spec­u­lat­ing on the cause for this dis­con­nect, I think it is fair to say that there is a severe lack of qual­ity research into the hold­ings of mutual funds and ETFs. There should not be such a large gap between the qual­ity of research on stocks and funds, which are sim­ply groups of stocks.

The full series of my reports on the Best & Worst Sec­tor and Style Funds is here. These works ana­lyze both qual­ity of hold­ings and the costs of all funds. My Style Fund Roadmap report ranks all 12 styles.

After all, investors should care more about the qual­ity of a fund's hold­ings than its costs because the qual­ity of a fund's hold­ings is the sin­gle most impor­tant fac­tor in deter­min­ing its future performance.

My Pre­dic­tive Rat­ing sys­tem rates 7400+ mutual funds and ETFs accord­ing to the qual­ity of their hold­ings (Port­fo­lio Man­age­ment Rat­ing) and their costs (Total Annual Costs Rat­ing).

The fol­low­ing is a sum­mary of my top picks and pans for all style funds. I fol­low this sum­mary with a detailed report on each style.

Fig­ures 1 shows the best fund in each invest­ment style as of Feb­ru­ary 2, 2012. There are no attrac­tive funds in any of the Mid-Cap and Small-Cap styles.

Fig­ure 1: Best Funds by Invest­ment Style

(Click charts to expand)


Charts Source: New Con­structs, LLC and com­pany filings

Fig­ure 2 shows the worst fund for each invest­ment style as of Feb­ru­ary 2, 2012.

Dangerous-or-worse-rated funds have a com­bi­na­tion of low-quality port­fo­lios (i.e. they hold too many Dangerous-or-worse rated stocks) and high costs (they charge investors too much for the [lack of] man­age­ment they provide).

Fig­ure 2: Worst Funds by Invest­ment Style


Ivy Funds: Ivy Small Cap Value Fund (IYSBX) is the worst small-cap value fund and gets my Very Dan­ger­ous rat­ing. The Port­fo­lio Man­age­ment rat­ing for this fund is Dan­ger­ous and the Total Annual Cost Rat­ing is Very Dan­ger­ous, result­ing in a lose-lose value propo­si­tion for investors. The man­agers at IYSBX have a lot of nerve charg­ing an investor over 5% per year over 3 years.

One of my least favorite stocks in this fund is Tri­umph Group, Inc. (NYSE:TGI). It gets my Very Dan­ger­ous rat­ing because of mis­lead­ing earn­ings and an expen­sive val­u­a­tion. The company's ROIC is 7%, well below its cost of cap­i­tal. To jus­tify its val­u­a­tion, the stock at $63 implies the com­pany will grow its prof­its at 10% com­pounded annu­ally for 15 years. Good luck.

Tra­di­tional mutual fund research has focused on past per­for­mance and low man­age­ment costs. The qual­ity of a fund's hold­ings has been ignored. Our Port­fo­lio Man­age­ment Rat­ing exam­ines the fund's hold­ings in detail and takes into account the fund's allo­ca­tion to cash. Our mod­els are cre­ated with data from over 40,000 annual reports. This kind of dili­gence is nec­es­sary for under­stand­ing just what you are buy­ing when you invest in a mutual fund or an ETF.

Fig­ure 3 shows the best fund based on our Port­fo­lio Man­age­ment Rat­ing for each invest­ment style as of Feb­ru­ary 2, 2012.

Attractive-or-better-rated funds own high-quality stocks and hold very lit­tle of the fund's assets in cash - investors look­ing to hold cash can do so them­selves with­out pay­ing man­age­ment fees. Only 2% of funds receive our Attrac­tive or Very Attrac­tive rat­ings, so investors need to be cau­tious when select­ing a mutual fund or ETF - there are thou­sands of Neutral-or-worse-rated funds.

Fig­ure 3: Funds With High­est Qual­ity Hold­ings by Invest­ment Style


Fig­ure 4 shows the worst fund based on our Port­fo­lio Man­age­ment Rat­ing for each invest­ment style as of Feb­ru­ary 2, 2012.

The worst fund for each invest­ment style is an actively man­aged mutual fund; none of the worst invest­ment style funds are pas­sively man­aged ETFs. Investors pay mutual fund man­agers to pick stocks for them. Even ignor­ing costs, mutual fund man­agers do a poor job invest­ing money for their clients.

Fig­ure 4: Funds With Low­est Qual­ity Hold­ings by Invest­ment Style


Investors should care about all of the fees asso­ci­ated with a fund in addi­tion to the qual­ity of the fund's hold­ings. The best funds have both low costs and qual­ity hold­ings - and there are plenty of low cost funds avail­able to investors.

Fig­ure 5 shows the best fund in each invest­ment style accord­ing to our Total Annual Costs Rat­ing.

Total Annual Costs incor­po­rates all expenses, loads, fees, and trans­ac­tion costs into a sin­gle value that is com­pa­ra­ble across all funds. Pas­sively man­aged ETFs and index mutual funds are gen­er­ally the cheap­est funds.

Fig­ure 5: Funds With Low­est Costs by Invest­ment Style


The most expense fund for each invest­ment style has a Very Dan­ger­ous Total Annual Costs Rat­ing. Investors should avoid these funds and other funds with a Very Dan­ger­ous Total Annual Costs Rat­ings because they charge investors too much. For every fund with a Very Dan­ger­ous Total Annual Costs Rat­ing there is an alter­na­tive fund that offers sim­i­lar expo­sure and hold­ings at a lower cost. We cover over 7000 mutual funds and over 400 ETFs. Investors have plenty of alter­na­tives to these over-priced funds.

Fig­ures 6 shows the worst fund in each invest­ment style accord­ing to our Total Annual Costs Rat­ing.

Fig­ure 6: Funds With High­est Costs by Invest­ment Style


Disclosure: I am long MSFT.

Source: Best And Worst Style Funds