Sector Rankings For ETFs and Mutual Funds

etfs etfsDavid Trainer: For the first quarter of 2014, only three sectors manage to even earn a Neutral rating. My sector ratings are based on the aggregation of my fund ratings for every ETF and mutual fund in each sector.

Investors looking for sector funds that hold quality stocks should look no further than the Consumer Staples sector. Only this sector houses Attractive-or-better rated funds. Figures 6 and 7 provide details. The primary driver behind an Attractive fund rating is good portfolio management, or good stock picking, with low total annual costs

Note that the Attractive-or-better Predictive ratings do not always correlate with Attractive-or-better total annual costs. This fact underscores that (1) low fees can dupe investors and (2) investors should invest only in funds with good stocks and low fees.

See Figures 4 through 13 for a detailed breakdown of ratings distributions by sector. See my free ETF & mutual fund screener for rankings, ratings and free reports on 7000+ mutual funds and 400+ ETFs. My fund rating methodology is detailed here.

All of my reports on the best & worst ETFs and mutual funds in every sector and investment style are available here.

Figure 1: Ratings For All Sectors

Screen shot 2014-01-13 at 9.38.03 AM

Source: New Constructs, LLC and company filings

To earn an Attractive-or-better Predictive Rating, an ETF or mutual fund must have high-quality holdings and low costs. Only four sector ETFs and mutual funds meet these requirements, which is only 0.5% of all sector ETFs and mutual funds.

State Street Consumer Staples Select Sector SPDR (NYSEARCA:XLP) is my top Consumer Staples ETF. It earns my Attractive rating by allocating over 39% of its value to Attractive-or-better-rated stocks.

The Coca-Cola Company (KO) is one of my favorite stocks held by XLP. KO earns my Attractive rating. KO has grown its economic earnings by 10% compounded annually over the past decade. The soft drink maker has earned a double-digit return on invested capital (ROIC) in every year of our model going back to 1998. Usually one has to pay a premium for a blue chip stock like KO, but it’s currently valued fairly modestly. At its current valuation of ~$40/share, KO has a market-implied growth appreciation period (GAP) of only five years. A more reasonable GAP for a Consumer Staples company would be between 15 and 20 years. If we give KO credit for 15 years of growth at a long-term rate of 6.5%, the stock is worth over $55/share today.

Rydex Series Funds: Utilities Fund (RYUTX) is my worst Utilities mutual fund. It gets my Very Dangerous rating by allocating over 91% of its value to Neutral-or-worse-rated stocks, and to make matters worse, charges investors total annual costs of 4.79%.

Duke Energy Corp (DUK) is one of my least favorite stocks held by RYUTX. DUK gets my Dangerous rating. DUK’s 2012 acquisition of Progress Energy helped it to grow revenue by $5 billion, but it added very little in shareholder value as DUK’s ROIC only increased by one-tenth of a percentage point to 3.6%. Unfortunately, the acquisition also helped balloon DUK’s debt from $21 billion to $42 billion. Add in DUK’s deferred tax liabilities and underfunded pensions and it has over $54 billion (112% of market cap) in long-term liabilities.

DUK’s current valuation of ~$68/share implies that the company will grow after-tax operating profit  (NOPAT) by 8% compounded annually for ten years. In the ten years prior to the Progress Energy acquisition, DUK’s NOPAT actually declined slightly. Prospects don’t look good for DUK to justify its valuation.

Figure 2 shows the distribution of our Predictive Ratings for all sector ETFs and mutual funds.

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