Small Cap Value Style

The Small Cap Value style ranks twelfth 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 15 ETFs and 262 mutual funds in the Small Cap Value style as of April 23, 2014. Prior reports on the best & worst ETFs and mutual funds in every sector and style are here.

Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the style. Not all Small Cap Value style ETFs and mutual funds are created the same. The number of holdings varies widely (from 18 to 1596), 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 Small Cap Value 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 Small Cap Value 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.

Get my ratings on all ETFs and mutual funds in this style by searching for Small Cap Value on my mutual fund and ETF screener. For more products, click here.

Figure 1: ETFs with the Best & Worst Ratings – Top 5

Screen shot 2014-04-29 at 9.53.59 AM* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Click here to see the four ETF’s that 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

Screen shot 2014-04-29 at 9.53.29 AM* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Click here to see the eight mutual funds that are excluded from Figure 2 because their total net assets (TNA) are below $100 million and do not meet our liquidity standards.

WisdomTree Small Cap Earnings Fund (EES) is my top-rated Small Cap Value ETF and Allianz Funds: AllianzGI NFJ Small-Cap Value Fund (ANFVX) is my top-rated Small Cap Value mutual fund. Both earn my Dangerous rating.

ProShares Ultra Russell 2000 Value (UVT) is my worst-rated Small Cap Value ETF and American Century Capital Portfolios, Inc: Small Cap Value Fund (ACSCX) is my worst-rated Small Cap Value mutual fund. UVT earns my Dangerous rating and ACSCX earns my Very Dangerous rating.

Figure 3 shows that 193 out of the 2214 stocks (over 9% of the market value) in Small Cap Value ETFs and mutual funds get an Attractive-or-better rating. However, 0 out of 15 Small Cap Value ETFs and 0 out of 262 Small Cap Value mutual funds get an Attractive-or-better rating.

The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and Small Cap Value ETFs hold poor quality stocks.

Figure 3: Small Cap Value Style Landscape For ETFs, Mutual Funds & Stocks

Screen shot 2014-04-29 at 9.52.58 AMSources: New Constructs, LLC and company filings

As detailed in “Low-Cost Funds Dupe Investors”, the fund industry offers many cheap funds but very few funds with high-quality stocks, or with what I call good portfolio management.

Investors need to tread carefully when considering Small Cap Value ETFs and mutual funds, as no ETFs or mutual funds in the Small Cap Value style allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating. Investors would be better suited with individual stocks for exposure to this investment style.

International Game Technology (IGT) is one of my favorite stocks held by Small Cap Value ETFs and mutual funds and earns my Very Attractive rating. Since bottoming out in 2009, IGT has grown after-tax profits (NOPAT) by 10% compounded annually. IGT has increased their return on invested capital (ROIC) to 11%, up from 7% in 2009. Despite this rebound IGT remains undervalued. At its current valuation of ~$12.50/share, IGT has a price to economic book value (PEBV) ratio of 0.8. This ratio implies the market expects IGT’s NOPAT to permanently decline by 20%. Such a sharp decline seems unlikely for a company whose profits are on an upward trajectory.

Unit Corporation (UNT) is one of my least favorite stocks held by Small Cap Value ETFs and mutual funds and earns my Very Dangerous rating. Over the past eight years, UNT’s NOPAT has declined by 1% compounded annually. The company currently earns a bottom quintile ROIC of 5%, down from 19% in 2005. UNT has only generated positive economic earnings in one of the 16 years in our model. Despite the poor fundamentals, the stock price is up over 50% in the past year, and the valuation has become unsustainably high. To justify the current price of ~$67, UNT would need to grow NOPAT by 12% compounded annually for the next 32 years. Such a high profit growth expectation seems overly optimistic given this company’s track record of declining profits.

Figures 4 and 5 show the rating landscape of all Small Cap Value 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

SCVF4Sources: New Constructs, LLC and company filings

Figure 5: Separating the Best Mutual Funds From the Worst Funds

SCVF5Sources: New Constructs, LLC and company filings

Review my full list of ratings and rankings along with reports on all 15 ETFs and 262 mutual funds in the Small Cap Value style.

To protect your portfolio from the worst ETFs and mutual funds, click here for a free trial.

Kyle Guske II contributed to this report.

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

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