The Best and Worst of the Small Cap Blend Style 2Q16

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The Small Cap Blend style ranks tenth out of the twelve fund styles as detailed in our 2Q16 Style Ratings for ETFs and Mutual Funds report. Last quarter, the Small Cap Blend style ranked eighth. It gets our Dangerous rating, which is based on aggregation of ratings of 24 ETFs and 702 mutual funds in the Small Cap Blend style as of May 4, 2016. See a recap of our 1Q16 Style Ratings here.

Figures 1 and 2 show the five best and worst rated ETFs and mutual funds in the style. Not all Small Cap Blend style ETFs and mutual funds are created the same. The number of holdings varies widely (from 21 to 2510). This variation creates drastically different investment implications and, therefore, ratings.

Investors seeking exposure to the Small Cap Blend style should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2.

NewConstructs_SmallCapBlendETFRatings_2Q16

* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

First Trust Dow Jones Select MicroCap Index (FDM) and iShares FactorSelect MSCI USA Small-Cap ETF (SMLF) are excluded from Figure 1 because their total net assets (TNA) are below $100 million and do not meet our liquidity minimums.

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

NewConstructs_SmallCapBlendMFRatings_2Q16

* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Lyons Small Cap Fund (LFSAX, LFSCX) and Oak Ridge Dynamic Small Cap Fund (ORSIX) are excluded from Figure 2 because their total net assets (TNA) are below $100 million and do not meet our liquidity minimums.

WisdomTree SmallCap Earnings Fund (EES) is the top-rated Small Cap Blend ETF and Boston Trust Small Cap Fund (BOSOX) is the top-rated Small Cap Blend mutual fund. EES earns an Attractive rating and BOSOX earns a Very Attractive rating.

Nashville Area ETF (NASH) is the worst rated Small Cap Blend ETF and Russell 2000 Fund (RYRRX) is the worst rated Small Cap Blend mutual fund. NASH earns a Dangerous rating and RYRRX earns a Very Dangerous rating.

Sanderson Farms (SAFM: $91/share) remains one of our favorite stocks held by EES and earns an Attractive rating. Sanderson Farms was a featured Long Idea in August 2015, and is up 26% since. Over the past decade, Sanderson Farms has grown after-tax profit (NOPAT) by 12% compounded annually. The company has significantly improved its return on invested capital (ROIC), which is up from 7% in 2012 to a top-quintile 15% over the last twelve months. Despite the price increase since our original report, SAFM remains undervalued. At its current price of $91/share, Sanderson Farms has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means that the market expects Sanderson’s NOPAT to permanently decline by 10% from its current levels. If Sanderson can grow NOPAT by just 6% compounded annually for the next five years, the stock is worth $186/share today – a 104% upside.

Kennedy-Wilson Holdings (KW: $21/share) is one of our least favorite stocks held by CTVAX and earns a Very Dangerous rating. Since 2009, despite reporting increasing GAAP net income, Kennedy-Wilson’s economic earnings have declined from -$10 million to -$212 million in 2015. Over the same time, the company’s ROIC has fallen from an already low 4% in 2009 to a bottom-quintile 2% in 2015. Despite the destruction of shareholder value, KW is up over 100% since going public in 2009. Such a price increase has left KW significantly overvalued. To justify its current price of $21/share, Kennedy-Wilson must grow NOPAT by 16% compounded annually for the next 11 years. Considering the decline in economic earnings, such lofty expectations for future cash flows make the downside risk of this stock too large.

Figures 3 and 4 show the rating landscape of all Small Cap Blend ETFs and mutual funds.

Figure 3: Separating the Best ETFs From the Worst Funds

NewConstructs_SmallCapBlendETFLandscape_2Q16

Sources: New Constructs, LLC and company filings

Figure 4: Separating the Best Mutual Funds From the Worst Funds

NewConstructs_SmallCapBlendMFLandscape_2Q16

Sources: New Constructs, LLC and company filings

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme.

Click here to download a PDF of this report.

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