Best & Worst ETFs and Mutual Funds May 2013: Large-cap Growth Style

The Large-cap Growth style ranks fourth out of the twelve fund styles as detailed in my Style Rankings for ETFs and Mutual Funds report. It gets my Neutral rating, which is based on aggregation of ratings of 23 ETFs and 717 mutual funds in the Large-cap Growth style as of May 2, 2013. 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 the Large-cap Growth style. Not all Large-cap Growth style ETFs and mutual funds are created the same. The number of holdings varies widely (from 18 to 577), 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 Large-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 seeking exposure to the Large-cap Growth style should buy one of the Attractive-or-better rated mutual funds from Figure 2. There are no good ETFs in this style.

Get my ratings on all ETFs and mutual funds in this style on my free mutual fund and ETF screener.

* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.

PowerShares RAFI Fundamental Pure Large Growth Portfolio (PXLG) is excluded from Figure 1 because its total net assets (TNA) are below $100 million and do not meet our liquidity standards.

* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Fidelity Large Cap Growth Enhanced Index Fund (FLGEX) is excluded from Figure 2 because its total net assets (TNA) are below $100 million and do not meet our liquidity standards.

PowerShares QQQ (QQQ) is my top-rated Large-cap Growth ETF and Aston Funds: ASTON/Montag & Caldwell Growth Fund (MCGIX) is my top-rated Large-cap Growth mutual fund. QQQ earns my Neutral rating and MCGIX earns my Attractive rating.

First Trust Large Cap Growth AlphaDEX Fund (FTC) is my worst-rated Large-cap Growth ETF and Quaker Strategic Growth Fund (QUAGX) is my worst-rated Large-cap Growth mutual fund. FTC earns my Neutral rating and QUAGX earns my Dangerous rating.

Figure 3 shows that 243 out of the 934 stocks (over 33% of the market value) in Large-cap Growth ETFs and mutual funds get an Attractive-or-better rating. However, no ETFs and only 14 out of 717 Large-cap Growth mutual funds (less than 3% of total net assets) get an Attractive-or-better rating.

I am astonished that no ETFs and just 2% of mutual funds allocate enough to the Attractive stocks in this style given that they make up 33% of the market value of stocks in the style.

The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and Large-cap Growth ETFs hold poor quality stocks.

As detailed in “Cheap 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 Large-cap Growth ETFs and mutual funds, as 99 out of 717 Large-cap Growth mutual funds (more than 16% of total net assets) earn a Dangerous rating. No ETFs and only Large-cap Growth mutual funds in the Large-cap Growth style allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating.

Colgate Palmolive (CL) is one of my favorite stocks held by Large-cap Growth ETFs and mutual funds and earns my Very Attractive rating. CL’s consistency throughout the years is impressive. It has posted only year of declining after tax profit (NOPAT) over the past 14, with a compounded annual growth rate (CAGR) of over 8% during that time period. Also impressive is its 22% return on invested capital (ROIC) in 2012. Given CL’s $1.3 billion in excess cash and $2.9 billion free cash flow, CL should have no problem funding investments to fuel further growth. For a company with such impressive consistency, CL is remarkably cheap. At its current valuation of ~$119.41/share, CL has a price to economic book value ratio of only 1.1. This low valuation implies that the market expects CL to grow its NOPAT by no more than 10% from its present value for its remaining corporate life. A large cap Consumer Staples company like CL is generally a safe bet, and at such a low valuation it becomes even safer.

Citigroup Inc. (C) is one of my least favorite stocks held by Large-cap Growth ETFs and mutual funds and earns my Dangerous rating. Citigroup’s issues did not start with the financial crisis. C has made negative economic earnings every year going back to 1998 when my model begins.

Given its outsized exposure (over $80 billion), relative to other banks, to bad mortgage assets, Citi is the most dependent on a housing turnaround to drive EPS growth. And that EPS growth will come from a reduction in credit costs not top line revenue growth. The outlook for the rest of Citi’s businesses and top line revenue growth is less than exciting as they depend on the pace of global growth. Moreover, I expect regulatory pressures to continue their gradual squeeze on big banks’ profits. Even if we get a turnaround in housing, I doubt it will be enough to justify the expectations for future profit growth already baked into Citi’s stock.

To justify its current share price of ~$45.87, C needs to grow NOPAT by 11% compounded annually for nine years. Such a high valuation means the potential benefit of the housing recovery is already priced into the stock. C is a company with no recent track record of economic profitability, and growth in the housing market is not enough to make it an attractive investment, especially not at such a high price.

Figures 4 and 5 show the rating landscape of all Large-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.

Review my full list of ratings and rankings along with reports on all 23 ETFs and 717 mutual funds in the Large-cap Growth style.

Sam McBride contributed to this report.

Disclosure: Sam McBride owns CL. David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, style or theme.