Best And Worst Funds: All-Cap Value Style

Includes: FRX, MAS
by: David Trainer

The all-cap value style ranks sixth out of the twelve fund styles as detailed in my style roadmap. It gets my Neu­tral rat­ing, which is based on aggre­gation of fund rat­ings of 288 all-cap value funds. Reports on the Best & Worst funds in every style and sec­tor are here.

Per Fig­ure 1, only 7 of the 288 funds (less than %1 of the total net assets) are wor­thy of invest­ment. Look­ing closer, 1749 stocks (over 68% of the mar­ket cap) held by all-cap growth funds get a Neutral-or-worse rat­ing. The take­away is: fund man­agers allo­cate too much cap­i­tal to low-quality stocks.

Investors seek­ing expo­sure to all-cap value stocks should buy a bas­ket of Attractive-or-better rated stocks and avoid pay­ing under­served 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: All-cap Value Style Land­scape For Funds & Stocks

Sources: New Con­structs, LLC and com­pany filings

The 288 all-cap value are very dif­fer­ent. Per Fig­ure 2, the num­ber of hold­ing varies widely (from 15 to 1968), which cre­ates dras­ti­cally dif­fer­ent invest­ment impli­ca­tions and rat­ings. Review my full list of rat­ings along with free reports on all 288 all-cap value 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 worst funds have poor hold­ings qual­ity and charge high total annual costs.

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 all-cap value fund is Fund­Van­tage Trust: For­mula Invest­ing US Value Select Fund (FNSIX), which gets my Attrac­tive rat­ing. One of its largest hold­ings and part of the 71% allo­cated to Attractive-or-better stocks is For­est Lab­o­ra­to­ries (NYSE:FRX), which gets my Very Attrac­tive rat­ing. I am bull­ish on the health care sec­tor and FRX is one of the best stocks in that sec­tor. The company's 2011 ROIC is over 50% and has stayed above 30% for the past 10 years. Over the same 10-year period, the com­pany has man­aged to increase eco­nomic earn­ings from $203.9 mil­lion to $954 mil­lion, a 467% increase. Given the weak state of FRX's drug port­fo­lio and impend­ing patent expi­ra­tions, it is dif­fi­cult to expect the com­pany to con­tinue its mete­oric value creation.

How­ever, the market's expec­ta­tion for a per­ma­nent 55% decline in after-tax cash flows (NOPAT) is too pes­simistic. My analy­sis, based on the stock's cur­rent val­u­a­tion at about $31.66/share, sug­gests that any drop in prof­its less than 55% will drive the stock up.

My worst-rated all-cap value fund is Amer­i­can Bea­con Mid-Cap Value Fund (MUTF:ABMAX), which gets my Very Dan­ger­ous rat­ing. One of its largest hold­ings and part of the 27% allo­cated to Dangerous-or-worse stocks is Masco Corp (NYSE:MAS), which gets my Dan­ger­ous rat­ing. I am gen­er­ally bear­ish on the mate­ri­als sec­tor and this stock is one of the worst in the sec­tor. The com­pany has not earned an ROIC greater than its cost of cap­i­tal (WACC) for the past 13 years, which is as far back as my model goes. Over the last 2 years, its ROIC is under 2%. Part of what dri­ves down ROIC in my model is the $3.1 bil­lion of write-offs the com­pany has made over the past 10 years. Man­age­ment has writ­ten off about 45 cents for every dol­lar of share­holder equity. This com­pany is a value destroyer. Investors deserve bet­ter stew­ard­ship of their capital.

Investors also owe it to them­selves to buy cheaper stocks. MAS' val­u­a­tion (~$12.82/share) implies the com­pany will grow NOPAT at 20% com­pounded annu­ally for over 13 years. I doubt even the best tech com­pany over the next 13 years will grow that fast.

Investors need to tread care­fully when con­sid­er­ing all-cap value funds, as 97% are not worth buy­ing. Only 7 of the 288 funds allo­cate enough value to Attractive-or-better-rated stocks to earn an Attrac­tive rat­ing. Fig­ure 4 shows the rat­ing land­scape of all ETFs and mutual funds in the all-cap value style.

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 all-cap value funds.

Fig­ure 5: Five Largest All-cap Value 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 288 all-cap value funds.

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