Best and Worst Funds: Industrials Sector

The Industrials sector ranks sixth out of the ten major sectors as detailed in our sector roadmap. It gets my Neutral rating, which, like my fund ratings, is based on aggre­ga­tion of stock rat­ings for each of 430+ companies in the sector. The full series of my reports on the Best & Worst Sector and Style Funds is here.

Industrials are likely to provide lackluster returns over the coming years given the dour economic outlook for global growth. The continued shift away from traditional industrial manufacturing toward more sophisticated manufacturing for more complex products like mobile phones means some industrial companies will perish while some are reborn. There will be few good Industrials.

There are fewer good Industrials funds. Figure 1 shows that picking the right mutual fund or ETF in the Industrials sector is more difficult than picking stocks in the sector. While over 20% of the market value of Industrials gets my Attractive-or-better rating, none of the 35 sector funds score as well.

Portfolio managers of funds in this sector are not doing a good job of selecting the best stocks in the sector. Investors should avoid funds in this sector because the cost of portfolio management (active or passive) is not justified. The best sectors for finding funds and stocks are Technology and Consumer Staples. My series of Best & Worst Funds reports on all sectors is here.

Figure 1: Industrials Sector Landscape For Funds & Stocks

Sources:   New Constructs, LLC and company filings

If you are forced to choose a fund in the Industrials sector, know that all 35 funds are very different. Per Figure 2, the number of holding varies widely (from 20 to 369), which creates drastically different investment implications and ratings. Here is the full list of 35 funds.

How do investors pick the right fund out of the sea of choices that will deliver the best 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 2.

Our predictive fund ratings are based on aggregating our stock ratings on each of the fund’s holdings and all of the fund’s expenses. Investors deserve forward-looking fund research that is comparable in quality to stock research.

Investors should not rely on backward-looking research of past performance for investment decisions.

Figure 3 shows the five best and worst-rated funds for the sector. Every fund in the sector over weights Neutral-or-worse rated stocks. Despite having lower allocations to Dangerous-or-worse-rated stocks, two classes of Rydex Series Funds: Transportation Fund RYNCX [s: RYNCX] and RYTSX [s: RYTSX] receive my Very Dangerous rating because their total annual costs are a whopping 5.01% and 5.98%. My ratings (updated daily) on all funds in this sector are here.

One of my favorite stocks in the Industrials sector is 3M Company  [s: MMM], which gets my Very Attractive rating. This company is an excellent example of an Industrial company that has positioned itself as a leader in sophisticated manufacturing. 3M considers itself a Technology, not an Industrial, company. That mindset is required to stay abreast of the constantly shifting landscape of technological innovation and manufacturing of the products created by that innovation. With an ROIC of 18%, 3M generates profits like a Technology company. And like all my Very Attractive-rated stocks, it has a cheap valuation. The current stock price (~$86.70/share) implies the company will not grow its profits more than 10% over the remainder of its corporate life. That seems a bit pessimistic for a company supplying key components to fast growing mobile phone and computer firms like Apple. The fund that allocates the most assets to MMM is Industrial Select Sector SPDR [s: XLI]. However, I do not recommend investors buy XLI because it gets my Neutral rating due to the fact that it allocates too much of the rest of its assets to Neutral-or-worse rated stocks. Per above, there are a few good stocks in the Industrials sector but no good funds.

One of my least favorite Industrials is Textron [s: TXT], which gets my Very Dangerous rating. Stuck in traditional Industrial activities like aerospace and defense, Textron is the opposite of 3M in many ways. First, Textron focuses primarily on traditional manufacturing of commercial and defense aircraft and automobiles. It also has a finance division and makes golf carts. Not a lot of focus here. Given expectations for cuts in spending of one of TXT’s largest customers, the US Defense Department, it is fair to say that growth prospects for TXT are not bright. However, the stock’s valuation tells another story. To justify its current stock price (~$25.48), the company must grow its profits (NOPAT) at over 15% for 20 years compounded annually. It is hard to believe that is possible for a company with TXT’s prospects and historical growth at a fraction of that level. I also recommend investors avoid SPDR S&P Aerospace & Defense ETF [s: XAR], which gets my Dangerous rating and has TXT as its largest holding.

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

Investors should not buy any Materials funds. None of the 35 funds allocate enough value to Attractive-or-better-rated stocks to earn an Attractive overall rating. Figure 4 charts the rating landscape of all ETFs and mutual funds in the Industrials sector.

Our Sector Roadmap report ranks all sectors and highlights those that offer the best investments.

Figure 4: Separating the Best Funds From the Worst

Sources:   New Constructs, LLC and company filings

Figure 5 lists our Predictive Fund Rating for the 5 largest and most popular Industrials funds.

Figure 5: Five Largest Industrials 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

The full list of Industrials funds and our ratings on each fund is here.

Dis­clo­sure: I receive no com­pen­sa­tion to write about any spe­cific stock, sec­tor or theme.

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