The Mid Cap Growth style ranks ninth out of the twelve fund styles as detailed in my Style Rankings for ETFs and Mutual Funds report. It gets my Dangerous rating, which is based on aggregation of ratings of 10 ETFs and 375 mutual funds in the Mid Cap Growth style as of April 17, 2014. Prior reports on the best & worst ETFs and mutual funds in every sector and style are here.
Figure 1 ranks from best to worst the eight mid-cap growth ETFs that meet our liquidity standards and Figure 2 shows the five best and worst-rated mid-cap growth mutual funds. Not all Mid Cap Growth style ETFs and mutual funds are created the same. The number of holdings varies widely (from 23 to 579), which creates drastically different investment implications and ratings. The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst, which allocate too much value to Neutral-or-worse-rated stocks.
To identify the best and avoid the worst ETFs and mutual funds within the Mid Cap Growth style, investors need a predictive rating based on (1) stocks ratings of the holdings and (2) the all-in expenses of each ETF and mutual fund. Investors need not rely on backward-looking ratings. My fund rating methodology is detailed here.
Investors should not buy any Mid Cap Growth ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this style, you 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.
Figure 1: ETFs with the Best & Worst Ratings
Sources: New Constructs, LLC and company filings
ProShares Ultra Russell MidCap Growth (UKW) and PowerShares RAFI Fundamental Pure Mid Growth Portfolio (PXMG) are excluded from Figure 1 because their total net assets (TNA) are below $100 million and do not meet our liquidity standards.
Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5
Sources: New Constructs, LLC and company filings
Delaware Pooled Trust: Focus Smid-Cap Growth Equity Portfolio (DCGTX) is excluded from Figure 2 because its total net assets (TNA) are below $100 million and do not meet our liquidity standards.
iShares Russell Mid-Cap Growth ETF (IWP) is my top-rated Mid Cap Growth ETF and Professionally Managed Portfolios: Congress Mid Cap Growth Fund (IMIDX) is my top-rated Mid Cap Growth mutual fund. Both earn my Neutral rating.
First Trust Mid Cap Growth AlphaDEX Fund (FNY) is my worst-rated Mid Cap Growth ETF and BlackRock Funds: BlackRock Mid-Cap Growth Equity Portfolio (BMGAX) is my worst-rated Mid Cap Growth mutual fund. FNY earns my Dangerous rating and BMGAX earns my Very Dangerous rating.
Figure 3 shows that 145 out of the 1435 stocks (over 9% of the market value) in Mid Cap Growth ETFs and mutual funds get an Attractive-or-better rating. However, only 0 out of 10 Mid Cap Growth ETFs and 0 out of 375 Mid Cap Growth mutual funds get an Attractive-or-better rating.
The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and Mid Cap Growth ETFs hold poor quality stocks.
Figure 3: Mid Cap Growth Style Landscape For ETFs, Mutual Funds & Stocks
Investors need to tread carefully when considering Mid Cap Growth ETFs and mutual funds, as no ETFs or mutual funds in the Mid Cap Growth style allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating. Investors wanting exposure to this investment style should look to individual stocks instead.
AutoZone (AZO) is one of my favorite stocks held by IWG and earns my Very Attractive rating. As I wrote in February, AZO is the best stock in the automotive retail sector based on both profitability and valuation. Over the past 15 years it has grown after tax profit (NOPAT) by 11% compounded annually. AZO’s return on invested capital (ROIC) of 25% is nearly double that of its closest competitor. AZO’s strong profitability gives it the ability to expand internationally and take advantage of growing opportunities in Latin America. Despite its impressive growth and profitability, AZO’s valuation of ~$520/share gives it a price to economic book value of just 1.1. This ratio implies that the market expects AZO to never grow NOPAT by more than 10% from its current level. Such a pessimistic expectation seems unwarranted for this market leader.
Patterson-UTI Energy, Inc. (PTEN) is one of my least favorite stocks held by Mid Cap Growth ETFs and mutual funds and earns my Dangerous rating. Over the past eight years, PTEN’s NOPAT has declined by 6% compounded annually. During the same time, PTEN’s ROIC has fallen to a bottom quintile 4%, down from 16% in 2005. Despite the long-term negative trends, PTEN is still priced as a high growth company. To justify its current value of ~$33/share, PTEN would need to grow NOPAT by 9% compounded annually for the next 23 years. This expectation is awfully optimistic for a company that has failed to grow for nearly a decade. Investors should avoid PTEN.
Figures 4 and 5 show the rating landscape of all Mid Cap Growth ETFs and mutual funds.
My Style Rankings for ETFs and Mutual Funds report ranks all styles and highlights those that offer the best investments.
Figure 4: Separating the Best ETFs From the Worst Funds
Figure 5: Separating the Best Mutual Funds From the Worst Funds
Review my full list of ratings and rankings along with reports on all 10 ETFs and 375 mutual funds in the Mid Cap Growth style.
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Kyle Guske II contributed to this report.
Disclosure: David Trainer owns AZO. David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, style or theme.