Tag Archives: radio

Avoid The Franklin Small-Mid Cap Growth Fund (FRSGX)

Each quarter we rank, the 12 investment styles in our Style Ratings For ETFs & Mutual Funds report. For the second quarter of 2016 rankings, we noticed a new trend: in five of the past six quarters, the Mid Cap Growth style has received our Dangerous rating. Within that group, we found a particularly bad fund. Of the five worst funds in this style, one in particular stands out for the high level of its assets under management (AUM). When a low quality fund has low AUM, we are comforted that investors are avoiding the poor fund. But, when a fund has over $3.4 billion AUM and receives our Very Dangerous rating, it’s clear that investors are missing pertinent details. The missing details are deep analysis of the fund’s holdings, which is the backbone of our ETF and Mutual Fund ratings . After all, the performance of a fund’s holdings drive the performance of a fund. As such, Franklin Small-Mid Cap Growth Funds (MUTF: FRSGX ) are in the Danger Zone due to alarmingly poor holdings and excessively high fees. Poor Holdings Makes Outperformance Unlikely The only justification for mutual funds to have higher fees than ETFs is “active” management that leads to out-performance. How can a fund that has significantly worse holdings than its benchmark hope to outperform? Franklin Small-Mid Cap Growth Fund investors are paying higher fees for asset allocation that is much worse than its benchmark, the iShares Russell Mid-Cap Growth ETF (NYSEARCA: IWP ). Per Figure 1, at 49%, Franklin Small-Mid Cap Growth Fund allocates more capital to Dangerous-or-worse rated stocks than IWP at just 32%. On the flip side, IWP allocates more (at 19% of its portfolio) to Attractive-or-better rated stocks than FRSGX at only 7%. Figure 1: Franklin Small-Mid Cap Growth Fund Portfolio Asset Allocation Click to enlarge Sources: New Constructs, LLC and company filings Furthermore, 7 of the mutual fund’s top 10 holdings receive our Dangerous rating and make up over 12% of its portfolio. Two stocks in particular raise enough red flags that we have featured them previously: Constellation Brands (NYSE: STZ ) and Willis Towers Watson (NASDAQ: WLTW ). If Franklin Small-Mid Cap Growth Fund holds worse stocks than IWP, then how can one expect the outperformance required to justify higher fees? Chasing Performance Is Lazy Portfolio Management Franklin Small-Mid Cap Growth Fund managers are allocating to some of the most overvalued stocks in the market. We think the days where investing based on past price performance (or momentum) leads to success have passed for the foreseeable future. Managers have to allocate capital more intelligently, not based on simple cues like momentum. The price-to-economic book value ( PEBV ) ratio for the Russell 2000 (NYSEARCA: IWM ), which includes all small and mid cap stocks, is 3.5. The PEBV ratio for FRSGX is 4.6. This ratio means that the market expects the profits for the Russell 2000 to increase 350% from their current levels versus 460% for FRSGX. Our findings are the same from our discounted cash flow valuation of the fund. The growth appreciation period ( GAP ) is 32 years for the Russell 2000 and 22 years for the S&P 500 – compared to 50 years for FRSGX. In other words, the market expects the stocks held by FRSGX to earn a return on invested capital ( ROIC ) greater than the weighted average cost of capital ( WACC ) for 18 years longer than the stocks in the Russell 2000 and 28 years longer than those in the S&P 500, home of some of the world’s most successful companies. This expectation seems even more out of reach when considering the ROIC of the S&P is 18%, or double the ROIC of stocks held in FRSGX. Significantly higher profit growth expectations are already baked into the valuations of stocks held by FRSGX. Beware Misleading Expense Ratios: This Fund Is Expensive With total annual costs ( TAC ) of 3.36%, FRSGX charges more than 84% of Mid Cap Growth ETFs and mutual funds. Coupled with its poor holdings, high fees make FRSGX even more Dangerous. More details can be seen in Figure 2, which includes the two other classes of the Franklin Small-Mid Cap Growth fund (MUTF: FSMRX ) that receive our Very Dangerous rating. For comparison, the benchmark, IWP charges total annual costs of 0.28%. Figure 2: Franklin Small-Mid Cap Growth Fund Understated Costs Click to enlarge Sources: New Constructs, LLC and company filings. Over a 10-year holding period, the 2.42 percentage point difference between FRSGX’s TAC and its reported expense ratio results in 27% less capital in investors’ pockets. To justify its higher fees, the Franklin Small-Mid Cap Growth Funds (MUTF: FRSIX ) must outperform its benchmark by the following over three years: FRSGX must outperform by 3.1% annually. FRSIX must outperform by 1.71% annually. FSMRX must outperform by 1.15% annually. The expectation for annual out performance gets harder to stomach when you consider how much the fund has underperformed already. In the past five years, FRSGX is down 24%, FRSIX is down 35%, and FSMRX is down 27%. Meanwhile, IWP is up 44% over the same time. Figure 3 has more details. The bottom line is that with such high costs and poor holdings, we think it unwise to invest in the belief that these mutual funds will ever outperform their much cheaper ETF benchmark. Figure 3: Franklin Small-Mid Cap Growth Funds’ 5 Year Return Click to enlarge Sources: New Constructs, LLC and company filings. The Importance of Proper Due Diligence If anything, the analysis above shows that investors might want to withdraw most or all of the $3.4 billion in Franklin Small-Mid Cap Growth Funds and put the money into better funds within the same style. The top rated Mid Cap Growth mutual fund for 2Q16 is Congress Mid Cap Growth Funds (IMIDX and CMIDX). Both classes earn a Very Attractive rating. The fund has only $375 million in AUM and IMIDX and CMIDX charge total annual costs of 0.95% and 1.23% respectively, both less than half of what FRSGX charges. Without analysis into a fund’s holdings, investors risk putting their money in funds that are more likely to underperform, despite having much better options available. Without proper analysis of fund holdings, investors might be overpaying and disappointed with performance. This article originally published here on May 9, 2016. Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

The Sweet Spot Of Zero Leverage Equity?

Global economic momentum is modest at best, equities and bonds are overvalued, and while allocating your funds entirely to gold, cash and shorts is enticing, it isn’t possible for the majority of money managers. What are investors to do then? The ranking of creditors and equity in the capital structure suggest that high-grade corporate bonds – and sovereigns – is the optimal allocation. When the going gets tough, the equity is wiped out, but as creditor, you are at least assured a recovery on your investment – even if it may be a slim one. This time could be different, however. As an alternative, I propose equities with zero leverage. There aren’t many around, and those that do remain unlevered are looked upon with suspicion by the market. After all, if the CFO hasn’t jumped on the bandwagon and issued debt to finance dividends and buybacks, she must be an idiot. But if you believe – as I do – that corporate bonds is the new bubble, being overweight equities with no leverage isn’t a bad idea. These securities won’t be immune to a crisis, but they offer two key advantages. Firstly, they likely will decline less than their overlevered brethren, and the risk of a bankruptcy is smaller. If a repeat of 2008 really beckons, capital preservation may turn out to be the key metric of survival, no matter the drawdown. Secondly, buying equities with zero, or very low, leverage is also a free option. If we are wrong, and the debt finance buyback and dividend party goes on, a portfolio of equities with zero leverage eventually will join the party too. In all likelihood, that means excess returns for your stocks. Once leverage has increased, you can sell and go looking for another batch of firms with no leverage, primed to lever their balance sheet to hand out money to shareholders. We concede that this latter rationale partly is a contradiction. But we would rather buy firms with a clean balance sheet than the alternative of buying equities that have already maxed out their potential for debt-financed shareholder gifts. Confusing charts; no directional clarity Meanwhile, looking at the macro, strategy and technical charts has left me confused – a bit like Macro Man , I suppose. Macroeconomic leading indicators have stabilised based on the most recent data. The year-over-year rate in the U.S. and EZ headline indices have climbed marginally, and have risen strongly in China. In Japan, however, the message from the headline index is grim. Global money supply growth has turned up further, helped by the U.S. and China. It is particularly encouraging to see that M1 growth has accelerated slightly in the U.S. On the contrary, my short-term charts of the market are sending a very unclear message. In the U.S. put-call ratios point to further upside despite the recent rally, while the advance-decline ratio continues to roll over. My equity valuation scores point to a slow grind higher in coming months, before a sell-off takes over towards the end of the summer. On sovereign bonds I remain bearish.

Junk Bond ETF ANGL Soaring: Will Its Flight Last?

Heightened volatility is driving investors to safe havens, making 2016 the year of the bond market. While long-term bonds are the undisputed winners, the high yield corner has drawn attention over the past three-months on investors’ drive for higher yields and a rebound in oil price. In addition, high-yield spreads have tightened significantly from 8.64 on February 12 to 6.36 currently, as per the BofA Merrill Lynch US High Yield Option-Adjusted Spread , making junk bonds attractive. This suggests that investors are now demanding lower premium than comparable Treasury bonds to compensate for the risk. However, the risk of default is on the rise, dampening the appeal for junk bonds. This is because the resumption of the slide in commodity prices and renewed global growth concerns are weighing on companies’ profits and balance sheets yet again. As per Moody’s Investors Service, global junk bond defaults will accelerate to 5% by the end of November, up from the previous forecast of 4.6% one month ago, and 3.8% in March. Fitch Ratings expects high yield bond defaults to climb to 6% this year from 4.5% last year and touch the highest level since 2000 (read: Junk versus Investment Grade Corporate Bond ETFs ). Given the heightened credit risk and low rate environment, investors thronged the high yield quality fund – VanEck Vectors Fallen Angel High Yield Bond ETF (NYSEARCA: ANGL ) . The fund gained 12.3% in the year-to-date time frame, outperforming the broad bond fund (NYSEARCA: BND ) and junk bond fund (NYSEARCA: JNK ) by wide margins. ANGL in Focus This ETF seeks to track the performance of the BofA Merrill Lynch US Fallen Angel High Yield Index, which focuses on the ‘fallen angel’ bonds. Fallen angel bonds are high yield securities that were once investment grade but have fallen from grace and are now trading as junk bonds. This unique approach gives the portfolio 248 securities that are widely spread across them, with none holding more than 1.65% of assets. The fund has an effective duration of 5.67 years and year to maturity of 9.33. Additionally, the product mainly comprises BB and B rated corporates, which together make up for 85.3% of the asset base. Bonds from energy and material sectors occupy the top two positions with 25.2% and 22.1%, respectively, while financial and communications round off the top four with double-digit allocation (read: all the High Yield Bond ETFs here ). ANGL has amassed $158.7 million in its asset base while trades in moderate volume of 82,000 shares a day on average. It charges a relatively low fee of 40 bps per year from investors and yields 5.20% per annum. Behind The Success of ANGL The fallen angels strategy is immensely successful this year as the number of fallen angels has increased substantially on a series of debt downgrades among energy and material firms – the top two sectors of the ETF. In this regard, Moody’s snatched investment grade ratings from 51 companies and gave them the junk status at the end of the first quarter, up from eight in the fourth quarter and 45 for the whole of 2015. These downgrades have boosted the performance of the ETF as bond price generally rebounds after losing an investment grade rating. Additionally, the rebound in oil prices from the 12-year low reached in mid-February injects further strength into these bonds and the ETF. As a result, fallen angels bonds tend to have lower default rates than their more traditional junk bond counterparts, thus offering better risk-reward profiles. These have a history of outperformance in nine out of the last 12 calendar years, according to Market Vectors. Moreover, the outperformance of ANGL was spurred by its higher average credit quality as about three-fourths of the portfolio carry the upper end rating (BB) of the junk category, leaving just less than 4% to the risky CCC-rated and lower. Link to the original post on Zacks.com