Best And Worst Funds: Mid-Cap Growth Style

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Includes: PCYC, TJX
by: David Trainer

The mid-cap growth style ranks sev­enth out of the twelve fund styles as detailed in my style roadmap. It gets my Dan­ger­ous rat­ing, which is based on aggre­gation of fund rat­ings of 396 mid-cap growth funds as of Feb­ru­ary 9, 2012. Arti­cles on all style and sec­tor funds are here.

Fig­ure 1 shows the alarm­ing truth that no mid-cap growth funds are wor­thy of invest­ment. All 396 earn a Neutral-or-worse rat­ing. Dig­ging into the qual­ity of the funds' hold­ings shows that 1163 out of the 1436 stocks (over 83% of the mar­ket cap) held by mid-cap growth funds get my Neutral-or-worse rat­ing. The take­away is: fund man­agers allo­cate too much cap­i­tal to low-quality stocks.

Investors seek­ing expo­sure to mid-cap growth stocks should buy a bas­ket of Attractive-or-better rated stocks and avoid pay­ing unde­served fund fees.

As detailed in "Cheap 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.

Fig­ure 1: Mid-cap Growth Style Land­scape For Funds & Stocks


Sources: New Con­structs, LLC and com­pany filings

The 396 mid-cap growth funds are very dif­fer­ent. Per Fig­ure 2, the num­ber of hold­ing varies widely (from 27 to 464), which cre­ates dras­ti­cally dif­fer­ent invest­ment impli­ca­tions and rat­ings. Review my full list of rat­ings along with free reports on all 396 mid-cap growth funds.

How do investors pick the fund that will most likely deliver the best future 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 3.

My pre­dic­tive fund rat­ings are based on aggre­gat­ing (1) my stock rat­ings on each of the fund's hold­ings and (2) all of the fund's expenses. Investors should not rely on backward-looking research.

Fig­ure 3 shows the five best and worst-rated funds for the style. The best funds allo­cate more value to Attractive-or-better-rated stocks than the worst funds and vice versa. The five worst funds offer poor qual­ity hold­ings and do not jus­tify their extremely high total annual costs, which range from 5.02% to a whop­ping 8.06%. My rat­ings and reports (updated daily) on all funds in this style are here.

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

My top-rated mid-cap growth fund is West­core Trust: West­core Select Fund (MUTF:WTSLX), which gets my Neu­tral pre­dic­tive rat­ing based on Neu­tral rat­ings for both its port­fo­lio man­age­ment and total annual costs.

One of its largest hold­ings and part of the 48% of the fund allo­cated to Attractive-or-better stocks is TJX Com­pa­nies, Inc. (NYSE:TJX), which gets my Attrac­tive rat­ing. If you are going to be in retail these days, dis­count retail is the place to be. TJX is very well-positioned to serve a grow­ing pop­u­la­tion of cost-conscious shop­pers who want to get the most for their money. In hard eco­nomic times, peo­ple have lit­tle desire to pay the pre­mi­ums charged for prod­ucts at the high-end, fancy stores. It is not prac­ti­cal. On the other hand, know­ing that money goes far­ther at a store like TJ Max makes that store very attrac­tive. One might expect that charg­ing lower prices would results in lower mar­gins for TJX, but that is not true. TJX has a very prof­itable busi­ness with a top-quintile ROIC of 17%. Its 2011 eco­nomic earn­ings grew more than its account­ing earn­ings after remov­ing non-operating charges and taxes from its reported results. Over the past five years, TJX has aver­aged 25% growth in eco­nomic earn­ings ver­sus just 15% in account­ing earnings.

The mar­ket is not giv­ing TJX's stock credit for its eco­nomic earn­ings growth. The cur­rent val­u­a­tion (~$34.57/share) implies about 6.5% eco­nomic earn­ings growth for 5 years. That looks low com­pared to what the com­pany has done and is posi­tioned to do.

My worst-rated mid-cap growth fund is Mutual Fund Series Trust: Even­tide Gilead Fund (MUTF:ETAGX), which gets my Very Dan­ger­ous pre­dic­tive rat­ing based on a Dan­ger­ous port­fo­lio man­age­ment rat­ing and a Very Dan­ger­ous total annual costs rat­ing. With total annual costs over 8%, this fund would not get an Attractive-or-better pre­dic­tive rat­ing no mat­ter how good the port­fo­lio man­age­ment. That this fund charges so much for poor port­fo­lio man­age­ment is a travesty.

One of its largest hold­ings and part of the 45% of the fund allo­cated to Dangerous-or-worse stocks is Phar­ma­cyclics Inc. (NASDAQ:PCYC), which gets my Very Dan­ger­ous rat­ing. The guys run­ning this fund bet­ter be PHDs for invest­ing in a bio-tech stock like PCYC. Noth­ing about this company's cur­rent finan­cials looks good. Its ROIC is -38%. Its 2011 eco­nomic earn­ings declined by more than its account­ing earn­ings. The finan­cials are worse than they appear on the surface.

The stock's val­u­a­tion (~$19.8/share), on the other hand, implies the company's prof­its will shoot the moon, i.e. grow its rev­enues by 100% com­pounded annu­ally for over 6 years. This company's drug pipeline would have to per­form bet­ter than most ratio­nal people's wildest dreams to meet those expec­ta­tions. The man­agers of ETAGX are get­ting paid very well to gam­ble with investors money. Ouch.

Fig­ure 4 shows the rat­ing land­scape of all mid-cap growth ETFs and mutual funds.

Our style roadmap report ranks all styles and high­lights those that offer the best investments.

Fig­ure 4: Sep­a­rat­ing the Best Funds From the Worst Funds


Sources: New Con­structs, LLC and com­pany filings

Fig­ure 5 lists our Pre­dic­tive Fund Rat­ing for the 5 largest and most pop­u­lar mid-cap growth funds.

Fig­ure 5: Five Largest Mid-cap Growth 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

Review my full list of rat­ings and rank­ings along with free reports on all 396 mid-cap growth funds.

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