Diversification is not a substitute for proper diligence. Sure, some advisors and pundits will sell you on ETFs and mutual funds as a way to reduce risk and minimize volatility. Spreading investments across stocks makes sense only if you spread across good stocks. Otherwise, you’re investing in a bunch of bad stocks instead of just one.
That’s a recipe for disaster.
Legacy fund research is not much help because it is backward looking and doesn’t analyze the stocks in a particular ETF or mutual fund.
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We do things differently. We analyze the holdings in funds. In fact, our fund ratings are entirely based on the holdings. So, if the fund holds a bunch of bad stocks, it gets a bad rating. And, vice versa. If it holds mostly Attractive-rated stocks, it can get an Attractive rating.
As you can imagine, this approach requires lots of work, more than any one analyst or even team of analysts can perform. That’s where our Robo-analyst technology comes in. It enables us to leverage our proven-superior fundamental research on the individual stock holdings of a fund to assess the profitability and valuation of the overall portfolio. This process enables us to create forward looking Risk/Reward ratings for 7,400+ ETFs and mutual funds. In other words, these ratings let investors know if a fund’s portfolio is filled with good or bad stocks.
In putting together our quarterly review of ETFs and mutual funds by both sector and style, we found a mid cap mutual fund that invests in companies that are less profitable and whose stocks are more expensive than its benchmark. Add in well above-average costs, and future outperformance of this fund looks unlikely.
In other words, we found a fund that invests in bad stocks and charges high fees. Talk about a double whammy. You’ll want to be sure you steer clear of this fund. And, because Morningstar gives this fund more positive ratings, we worried that a lot of investors might be invested in this fund.
Below is an excerpt from the full report, available to Pro and Institutional members. And, you can buy the full report a la carte here.
Forward-Looking Research Protects Investors
Figure 1 in the full report shows how our forward-looking Fund Ratings compare to Morningstar’s (MORN) ratings. We rate this fund Very Unattractive (equivalent to Morningstar’s 1 Star) while Morningstar gives the fund a 3 Star rating. Three other share classes of the fund also earn a 3 Star rating while we rate them Unattractive.
Figure 1: Comparing Fund Ratings
Sources: New Constructs, LLC, company filings, mutual fund filings, and Morningstar
Holdings Research Reveals a Low-Quality Mid Cap Portfolio
Our holdings analysis, which leverages our Robo-Analyst technology, reveals that this fund holds lower-quality stocks than its benchmark. For reference, the benchmark earns an Attractive rating.
Per Figure 2 in the full report, this fund allocates 69% of its portfolio to Unattractive-or-worse rated stocks compared to 50% for the benchmark. On the flip side, this fund allocates only 5% of its assets to Attractive-or-better rated stocks compared to 7% for the benchmark.
Per Figure 3 in the full report, our holdings analysis also reveals this fund’s portfolio is lower quality than the S&P 500, as represented by State Street SPDR S&P 500 ETF (SPY), which earns an Attractive rating.
At just 38% of its portfolio, SPY allocates less to Unattractive-or-worse rated stocks compared to this fund. On the flip side, at 6% of its portfolio, SPY’s exposure to Attractive-or-better rated stocks is just slightly higher than this fund.
….there’s much more in the full report. You can buy the report a la carte here.
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