The mid-cap growth style ranks seventh out of the twelve fund styles as detailed in my style roadmap. It gets my Neutral rating, which is based on aggregation of ratings of ten ETFs and 387 mutual funds in the mid-cap growth style as of May 1, 2012.
Figures 1 and 2 rank the five best and worst-rated ETFs and mutual funds in the style. 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.
Investors should use 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 - Top 5
Sources: New Constructs, LLC and company filings
Figure 2: Mutual Funds with the Best & Worst Ratings - Top 5
* Best mutual funds exclude funds with NAV's less than 100 million.
Sources: New Constructs, LLC and company filings
Vanguard Mid-Cap Growth ETF (VOT) is my top-rated mid-cap growth ETF and Nicholas II, Inc: Class I Shares (NCTWX) 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 Mutual Fund Series Trust: Eventide Gilead Fund (ETAGX) is my worst-rated mid-cap growth mutual fund. Both earn my Very Dangerous rating. ETAGX's total annual costs of 8.8% are the third highest costs of all 7000+ mutual funds I cover.
Figure 3 shows that only 315 out of the 1463 stocks (less than 24% of the total net assets) held by mid-cap growth ETFs and mutual funds get an Attractive-or-better rating. The style's low allocation to attractive-or-better rated stocks is the reason none of the ten ETFs and 387 mutual funds are worth buying. We believe the quality of a fund is determined primarily by the quality of its holdings.
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
Sources: New Constructs, LLC and company filings
Investors need to tread carefully when considering mid-cap growth ETFs and mutual funds, as none are worth buying. In fact, five of the ten ETFs and 224 of the 387 mutual funds in the mid-cap growth style should be sold and avoided all together. Focus on individual stocks instead.
Aaron's Inc. (AAN) is one of my favorite stocks held by mid-cap growth ETFs and mutual funds and earns my Very Attractive rating. Our society is becoming more materialistic with each passing year and consumers want the newest and best even if they can't afford it sometimes. Aaron's enables consumers to lease comforts that most wouldn't be able to afford without years of savings. Aaron's strong business model manifests in ten years of consistent growth in after-tax cash flow (NOPAT). And yet, Aaron's current valuation (~$27.17) implies that profits will permanently decrease by 20%. The economy might be sluggish I think it is unlikely Aaron's NOPAT will decline nearly as much as its stock price implies.
Nuance Communications, Inc (NUAN) is one of my least favorite stocks held by mid-cap growth ETFs and mutual funds and earns my Very Dangerous rating. Given our ever-increasing dependency on technology, I'm generally bullish on Information Technology stocks, but NUAN is an exception. The company earns a disappointing 3% return on invested capital (ROIC) and discloses accounting earnings that are positive and rising while economic earnings are actually negative and decreasing. Moreover, to justify its current valuation (~$24.43), the company must grow profits by 10% annually for 35 years. The company's poor economics and high performance hurdle present investors a poor risk/reward trade-off.
Figures 4 and 5 show the rating landscape of all mid-cap growth ETFs and mutual funds.
Figure 4: Separating the Best ETFs From the Worst Funds
Sources: New Constructs, LLC and company filings
Figure 5: Separating the Best Mutual Funds From the Worst Funds
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ources: New Constructs, LLC and company filings
Review my full list of ratings and rankings along with free reports on all ten ETFs and 387 mutual funds in the mid-cap growth style on my website.
Disclosure: I receive no compensation to write about any specific stock, sector, style or theme.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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