Best And Worst Sector ETFs (And Mutual Funds)

The best ETFs and mutual funds have high-quality holdings and low costs. There are few funds that have both good holdings and low costs. There are lots of cheap funds, but there are too few funds with high-quality holdings.
 
I think there are at least two causes for this disconnect. First, there is, in general, a lack of independent research on ETFs and funds. Second, I think it is fair to say that there is a severe lack of quality research into the holdings of mutual funds and ETFs. There should not be such a large gap between the quality of research on stocks and funds, which are simply groups of stocks.
 
After all, investors should care more about the quality of a fund’s holdings than its costs because the quality of a fund’s holdings is the single most important factor in determining its future performance.
 
The following is a summary of my top picks and pans for all sector funds. I will follow this summary with a detailed report on each sector.
 
Figures 1 shows the best ETF or mutual fund in each sector as of April 13, 2012.
 
For a full list of all ETFs and mutual funds for each sector ranked from best to worst, see my free ETF & mutual fund screener.
 
Figure 1: Best ETF or Mutual Fund by Sector

Source: New Constructs, LLC and company filings

Only one sector fund gets my Very Attractive rating, Health Care Select Sector SPDR (XLV). Over 30% of this fund is allocated to Very Attractive stocks, including Merck & Co., Inc. (MRK) and Abbott Laboratories (ABT). Another 35%+ is allocated to Attractive stocks. About 28% is in Neutral stocks while less than 3% is in Dangerous-or-worse-rated stocks.

One of the fund’s top holding is MRK. With positive and rising economic earnings and a valuation that implies at permanent 10% decline in profits, MRK offers teriffic risk/reward.

Figure 2 shows the worst ETF or mutual fund for each sector as of April 13, 2012.

Dangerous-or-worse-rated funds have a combination of low-quality portfolios (i.e. they hold too many Dangerous-or-worse rated stocks) and high costs (they charge investors too much for the [lack of] management they provide).

Figure 2: Worst ETF or Mutual Fund by Sector


Source:New Constructs, LLC and company filings
 
Fidelity Advisors Series VII: Fidelity Advisor Biotechnology Fund [FBTAX] is the worst health care fund and gets my Very Dangerous rating. The Portfolio Management rating for this fund is Dangerous and the Total Annual Cost Rating is Dangerous, resulting in a lose-lose value proposition for investors. The managers at FBTAX have a lot of nerve charging an investor over 8% per year over 3 years.
 
One of my least favorite stocks in this fund is SIGA Technologies, Inc. (SIGA). It gets my Very Dangerous rating because of misleading earnings and an expensive valuation. The company’s ROIC is    -28%, well below its cost of capital. To justify its valuation, the stock at $3 implies the company will grow its profits at 50% compounded annually for 15 years. Good luck.
 
Traditional mutual fund research has focused on past performance and low management costs. The quality of a fund’s holdings has been ignored. Our Portfolio Management Rating examines the fund’s holdings in detail and takes into account the fund’s allocation to cash. Our models are created with data from over 50,000 annual reports. This kind of due diligence is necessary for understanding just what you are buying when you invest in a mutual fund or an ETF.
 
Figure 3 shows the best ETF or mutual fund based on our Portfolio Management Rating for each sector as of April 13, 2012.
 
Attractive-or-better-rated funds own high-quality stocks and hold very little of the fund’s assets in cash – investors looking to hold cash can do so themselves without paying management fees. Only 2% of funds receive our Attractive or Very Attractive Portfolio Management ratings, so investors need to be cautious when selecting a mutual fund or ETF – there are thousands of Neutral-or-worse-rated funds.
 
Figure 3: ETF or Mutual Fund With Highest Quality Holdings by Sector 

Source: New Constructs, LLC and company filings

Figure 4 shows the worst ETF or mutual fund based on our Portfolio Management Rating for each sector as of April 13, 2012.

Even ignoring costs, many ETFs and mutual fund do a poor job investing money for their clients. These funds are not worth owning at any cost.

Figure 4: ETF or Mutual Fund With Lowest Quality Holdings by Sector


Source:  New Constructs, LLC and company filings
 
Investors should care about all of the fees assocated with a fund in addition to the quality of the fund’s holdings. The best ETFs and mutual funds have both low costs and quality holdings – and there are plenty of low cost funds available to investors.
 
Figures 5 shows the best ETF or mutual fund in each sector according to our Total Annual Costs Rating.
 
Total Annual Costs incorporates all expenses, loads, fees, and transaction costs into a single value that is comparable across all ETFs and mutual funds. Passively managed ETFs and index mutual funds are generally the cheapest funds.
 
Figure 5: ETF or Mutual Fund With Lowest Costs by Sector 

Source:  New Constructs, LLC and company filings
 
The most expense fund for each sector has a Very Dangerous Total Annual Costs Rating. Guggenheim Investments Electronics Fund  [RYELX], the most expensive Industrials mutual fund, charges investors a Total Annual Cost of 7.7%. Investors should avoid these funds and other funds with a Very Dangerous Total Annual Costs Ratings because they charge investors too much.

For every fund with a Very Dangerous Total Annual Costs Rating there is an alternative fund that offers similar exposure and holdings at a lower cost. Investors have plenty of alternatives to these over priced funds.
 
Figures 6 shows the worst fund in each sector according to our Total Annual Costs Rating.
 
Figure 6: ETF or Mutual Fund With Highest Costs by Sector 

Source: New Constructs, LLC and company filings

Disclosure: I receive no compensation to write about any specific stock, sector or theme.