Best And Worst Funds: Small-Cap Blend Style

Includes: CDE, IJR, IWM, SPOK
by: David Trainer

The small-cap blend style ranks eleventh 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 681 small-cap blend funds as of Feb 14th 2012. Arti­cles on the funds in each sec­tor and style are here.

Per Fig­ure 1, none of the 681 small-cap growth funds are worth buy­ing. In fact, 83% of the funds should be sold because they get my Dangerous-or-worse rat­ing. Poor port­fo­lio man­age­ment dri­ves the poor fund rat­ings. 2231 of the 2640 stocks (over 80% of the mar­ket cap) held by small-cap blend funds earn a Neutral-or-worse rat­ing. The take­away is: fund man­agers allo­cate too much cap­i­tal to low-quality stocks.

Investors seek­ing expo­sure to small-cap blend stocks 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.

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: Small-Cap Blend Style Land­scape For Funds & Stocks

Sources: New Con­structs, LLC and com­pany filings

The 681 small-cap blend funds are very dif­fer­ent. Per Fig­ure 2, the num­ber of hold­ing varies widely (from 26 to 2541), which cre­ates dras­ti­cally dif­fer­ent invest­ment impli­ca­tions and rat­ings. Review my full list of rat­ings along with free reports on all 681 small-cap blend 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 of past performance.

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 offer poor port­fo­lio man­age­ment 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 small-cap blend fund is Mutual Fund Series Trust: Cat­a­lyst Value Fund (MUTF:CTVIX), which gets my Neu­tral rat­ing. One of its largest hold­ings and part of the 40% allo­cated to Attractive-or-better stocks is USA Mobil­ity, Inc. (USMO), which gets my Very Attrac­tive rat­ing. Unlike a major­ity of the Tele­com stocks, USA Mobil­ity is a value cre­ator, not destroyer. Details on Tele­com sec­tor funds are here.

The com­pany has had a pos­i­tive and increas­ing ROIC in each of the past 5 years, with a top-quintile ROIC of 16% dur­ing 2010. USMO is one of the few Tele­com stocks cre­at­ing value.

Despite strong eco­nomic earn­ings growth, its cur­rent price of ~$14.91/share implies its after-tax cash flows (NOPAT) will per­ma­nently decrease by 60%. If the company's NOPAT just remains flat (no-growth sce­nario) for­ever, the stock is worth over $30.

My worst-rated small-cap blend fund is For­ward Funds: For­ward Small Cap Equity Fund (FFHAX), which gets my Very Dan­ger­ous rat­ing. One of its largest hold­ings and part of the 53% allo­cated to Dangerous-or-worse stocks is Coeur D'alene Mines Corp (NYSE:CDE), which gets my Dan­ger­ous rat­ing. CDE is a bottom-quintile ROIC busi­ness (1.7%) with a track record of destroy­ing value.

Over the past 13 years, man­age­ment has writ­ten off nearly 10 cents of every dol­lar of equity cap­i­tal on the bal­ance sheet. Not exactly an inspir­ing per­for­mance. Details on how write-offs reflect poorly on man­age­ment are here.

The company's cur­rent stock price seems to ignore CDE's his­tor­i­cally poor cap­i­tal man­age­ment. At ~$27.01/share, the stock implies the com­pany will increase NOPAT by nearly over 16% com­pounded annu­ally for almost 20 years. I seri­ously doubt this kind of turn­around from a com­pany that has never earned a return greater than its weighted aver­age cost of cap­i­tal (WACC).

Investors should avoid all small-cap blend funds, as none are not worth buy­ing. 83% of the funds earn a Dangerous-or-worse rat­ing and should be sold. Fig­ure 4 shows the rat­ing land­scape of all small-cap blend 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 small-cap blend funds.

Fig­ure 5: Five Largest Small-cap Blend 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 681 small-cap blend funds at

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