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The small-cap blend style ranks tenth out of the twelve fund styles as detailed in my style roadmap. It gets my Dangerous rating, which is based on aggregation of ratings of 27 ETFs and 639 mutual funds in the small-cap blend style as of May 1, 2012.

Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the style. The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst, which allocate too much value to Neutral-or-worse-rated stocks.

Investors should use a predictive rating based on (1) stocks ratings of the holdings and (2) the all-in expenses of each ETF and mutual fund. Investors need not rely on backward-looking ratings. My fund rating methodology is detailed here.

Investors should not buy any small-cap blend ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this style, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off.

Figure 1: ETFs with the Best & Worst Ratings - Top 5

* Best ETFs exclude ETFs with less NAV's less than 100 million.

Sources: New Constructs, LLC and company filings

Figure 2: Mutual Funds with the Best & Worst Ratings - Top 5

* Best mutual funds exclude funds with NAV's less than 100 million.

Sources: New Constructs, LLC and company filings

Virtus Equity Trust: Virtus Quality Small-Cap Fund (PXQSX) is my top-rated small-cap blend mutual fund and earns my Neutral rating. I recommend investors avoid small-cap blend ETFs, all of which earn my Dangerous rating.

iShares Russell Microcap Index Fund (NYSEARCA:IWC) is my worst-rated small-cap blend ETF and earns my Dangerous rating. SunAmerica Focused Series, Inc: Focused Small-Cap Value Portfolio [s: SSSAX] is my worst-rated small-cap blend mutual fund and earns my Very Dangerous rating.

Figure 3 shows that 430 out of the 2669 stocks (over 22% of the total net assets) held by small-cap blend ETFs and mutual funds get an Attractive-or-better rating. However, none of the 27 small-cap blend ETFs and none of 639 small-cap blend mutual funds get an Attractive-or-better rating.

The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and small-cap blend ETFs hold poor quality stocks.

Figure 3: Small-cap Blend Style Landscape For ETFs, Mutual Funds & Stocks

Sources: New Constructs, LLC and company filings

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.

Investors need to tread carefully when considering small-cap blend ETFs and mutual funds, as none of the ETFs or mutual funds in the small-cap blend style allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating. Focus on individual stocks instead.

ADTRAN Inc. (NASDAQ:ADTN) is one of my favorite stocks held by small-cap blend ETFs and mutual funds and earns my Very Attractive rating. ADTN has generated an economic earnings margin over 23% for the last eight years. ADTN's current stock price of $30.52 implies that the company's after-tax cash flows (NOPAT) will decline by 6% permanently. High historical profits and low expectations for future profits make for good risk/reward.

Equity Lifestyle Properties, Inc. (NYSE:ELS) is one of my least favorite stocks held by small-cap blend ETFs and mutual funds and earns my Very Dangerous rating. ELS has misleading earnings, which means that it's reported earnings are positive and rising while its economic earnings are negative and declining. In fact, the company hasn't had positive economic earnings since at least 1998. ELS's current stock price of $69.94 implies that the company will grow NOPAT by 16% annually for the next 15 years, a growth rate that the company has achieved only once in the last 10 years. Investor's should avoid stocks with such high expectations for future profits especially when the company has such a poor track record for profits.

Figures 4 and 5 show the rating landscape of all small-cap blend ETFs and mutual funds.

Figure 4: Separating the Best ETFs From the Worst Funds

Sources: New Constructs, LLC and company filings

Figure 5: Separating the Best Mutual Funds From the Worst Funds


(Click to enlarge)

Sources: New Constructs, LLC and company filings

Review my full list of ratings and rankings along with free reports on all 27 ETFs and 639 mutual funds in the small-cap blend style on my website.

Source: Best And Worst ETFs And Mutual Funds: Small-Cap Blend