This report shows how well sector ETF and mutual fund managers pick stocks. We juxtapose our portfolio management rating on funds, which grades managers based on the quality of the stocks they choose, with the number of good stocks available across all sectors. This analysis shows whether or not ETF providers and mutual fund managers deserve their fees.
For example, if a fund has a poor portfolio management rating, that fund does not deserve the fees it charges, and investors are much better off putting money in a passively-managed fund or investing directly in good stocks. On the other hand, if a fund has a good portfolio management rating, then investors should put money in that fund, assuming the fund’s costs are competitive.
Figure 1 compares the number of good stocks to the number of good funds. 364 out of the 2997 stocks (over 27% of the market value) held in sector ETFs and mutual funds get an Attractive-or-better rating.
Only 2% (3 out of 189) of sector ETFs allocate enough to quality stocks to earn an Attractive-or-better portfolio management rating. Mutual fund managers have not fared any better. Only 1% (8 out of 649) of sector mutual funds allocate enough of their assets to quality stocks to earn an Attractive-or better portfolio management rating. ETF providers and mutual fund managers need to do a better job to justify their fees.
Figure 1: Comparing Quality of Stock Picking to Quality of Stocks Available
Sources: New Constructs, LLC and company filings
PowerShares KBW Property & Casualty Insurance Portfolio ETF (KBWP) has the highest portfolio management rating of all sector ETFs and earns our Attractive portfolio management rating. Fidelity Select Consumer Staples Portfolio (FDFAX) has the highest portfolio management rating of all sector mutual funds and earns our Attractive portfolio management rating.
State Street SPDR S&P Oil & Gas Exploration & Production ETF (XOP) has the lowest portfolio management rating of all sector ETFs and earns our Dangerous portfolio management rating. World Funds REMS Real Estate Value-Opportunity Fund (HLPPX) has the lowest portfolio management rating of all sector mutual funds and also earns our Dangerous portfolio management rating.
The Travelers Companies (TRV) is one of our favorite stocks held by KBWP and earns our Very Attractive rating. Over the last decade, Travelers’ after tax profit (NOPAT) has grown by 14% compounded annually. In the same timeframe, the company has tripled its return on invested capital (ROIC) from 4% to 12%. Despite this consistent growth generated by Travelers, the stock remains undervalued. At its current price of ~$100/share, TRV has a price to economic book value (PEBV) ratio of 0.6. This ratio implies that the market expects Travelers Companies’ NOPAT to permanently decline 40% over its remaining corporate life. This expectation seems extremely pessimistic considering the company has grown NOPAT by 14% a year for a decade. Investors should look into this fundamentally strong company while it remains undervalued.
Alexandria Real Estate Equities, Inc. (ARE) is one of our least favorite holdings of HLPPX and earns our Very Dangerous rating. Since 2010, Alexandria Real Estate’s NOPAT has declined by 7% compounded annually. Over the last decade, the company’s ROIC has more than halved, from 6%, to its current 2%, ranking in the bottom quintile of all companies we cover. Even more concerning, since going public in 1998, Alexandria Real Estate has never generated positive economic earnings and has only achieved positive free cash flow once. Investors appear to be ignoring the current state of business, as the stock price is up almost 20% in the past year. To justify its current price of ~$92/share, Alexandra Real Estate Equities would need to grow NOPAT by 7% compounded annually for the next 33 years. Expecting Alexandra Real Estate to sustain positive growth for more than three decades seems unrealistic given its past struggles.
Our Sector Ratings for ETFs & Mutual Funds reveal our predictive ratings on the best and worst funds in each sector.
Disclosure: David Trainer owns TRV. David Trainer and Max Lee receive no compensation to write about any specific stock, sector, or theme.
Photo Credit: Michael Pollak (Flickr)