How To Avoid The Worst Style Mutual Funds: Q1'16

|
Includes: AMREX, CMIIX, GARUX, PUMYX, PVEYX, SSMHX, VSMPX
by: David Trainer

Summary

The large number of mutual funds has little to do with serving your best interests.

Below are three red flags you can use to avoid the worst mutual funds.

The following presents the least and most expensive style mutual funds as well as the worst overall style mutual funds per our Q1'16 style ratings.

Question: Why are there so many mutual funds?

Answer: Mutual fund providers tend to make lots of money on each fund, so they create more products to sell.

The large number of mutual funds has little to do with serving investors' best interests. Below are three red flags investors can use to avoid the worst mutual funds:

  1. Inadequate Liquidity

This issue is the easiest issue to avoid, and our advice is simple. Avoid all mutual funds with less than $100 million in assets. Low levels of liquidity can lead to a discrepancy between the price of the mutual fund and the underlying value of the securities it holds. Plus, low asset levels tend to mean lower volume in the mutual fund and larger bid-ask spreads.

  1. High Fees

Mutual funds should be cheap, but not all of them are. The first step here is to know what is cheap and expensive.

To ensure you are paying at or below average fees, invest only in mutual funds with total annual costs below 1.92%, which is the average total annual cost of the 6336 U.S. equity Style mutual funds we cover. The weighted average is lower at 1.28%, which highlights how investors tend to put their money in mutual funds with low fees.

Figure 1 shows that the American Growth Fund Series Two Fund (MUTF:AMREX) is the most expensive style mutual fund and the Vanguard Total Stock Market Index Fund (MUTF:VSMPX) is the least expensive. The American Growth Fund (AMREX, AMRHX, AMRAX, AMRBX, and AMRGX) provides five of the most expensive mutual funds while Vanguard mutual funds (VSMPX, VIIIX, and VITPX) are among the cheapest.

Figure 1: 5 Least and Most Expensive Style Mutual Funds

Click to enlarge

Sources: New Constructs, LLC and company filings

Investors need not pay high fees for quality holdings. The Calvert Large Cap Portfolio (MUTF:CMIIX) earns our Very Attractive rating and has low total annual costs of only 0.91%.

On the other hand, a fund such as the State Street Small Mid Cap Equity Index Portfolio (MUTF:SSMHX) holds poor stocks. No matter how cheap a mutual fund (0.03% TAC), if it holds bad stocks, its performance will be bad. The quality of a mutual fund's holdings matters more than its price.

  1. Poor Holdings

Avoiding poor holdings is by far the hardest part of avoiding bad mutual funds, but it is also the most important because a mutual fund's performance is determined more by its holdings than its costs. Figure 2 shows the mutual funds within each style with the worst holdings or portfolio management ratings.

Figure 2: Style Mutual Funds with the Worst Holdings

Click to enlarge

Sources: New Constructs, LLC and company filings

PACE Select Advisors Trust (PVEYX and PUMYX) appears more often than any other providers in Figure 2, which means that they offer the most mutual funds with the worst holdings.

The Goldman Sachs Absolute Return Tracker Fund (MUTF:GARUX) is the worst rated mutual fund in Figure 2. Seven other mutual funds (ARVIX, IDVIX, PVEYX, PUMYX, MOFQX, SYIMX, HDPCX, ETILX and NAAIX) also earn a Very Dangerous predictive overall rating, which means not only do they hold poor stocks, they charge high total annual costs.

Our overall ratings on mutual funds are based primarily on our stock ratings of their holdings.

The Danger Within

Buying a mutual fund without analyzing its holdings is like buying a stock without analyzing its business and finances. Put another way, research on mutual fund holdings is necessary due diligence because a mutual fund's performance is only as good as its holdings' performance.

PERFORMANCE OF MUTUAL FUND's HOLDINGs = PERFORMANCE OF MUTUAL FUND

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme.

Disclosure: I/we 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.