How To Avoid The Worst Style Mutual Funds 1Q22

Question: Why are there so many mutual funds?

Answer: Mutual fund providers tend to make lots of money on each fund, so they create more products to sell.

The large number of mutual funds has little to do with serving your best interests. I identify three red flags you can use to avoid the worst mutual funds:

1. Inadequate Liquidity

This issue is the easiest issue to avoid, and my advice is simple. Avoid all mutual funds with less than $100 million in assets. Low levels of liquidity can lead to a discrepancy between the price of the mutual fund and the underlying value of the securities it holds.

2. High Fees

Mutual funds should be cheap, but not all of them are. The first step here is to know what is cheap and expensive.

To ensure you are paying at or below average fees, invest only in mutual funds with total annual costs below 1.64% which is the average total annual cost of the 5,769 U.S. equity Style mutual funds my firm covers. The weighted average is lower at 0.93%, which highlights how investors tend to put their money in mutual funds with low fees.

Figure 1 shows American Growth Fund Series One (AMRBX) is the most expensive style mutual fund and Vanguard 500 Index Fund (VFFSX) is the least expensive. American Growth (AMRBX, AMRAX, AMRGX) provides three of the most expensive mutual funds while Vanguard (VFFSX, VSTSX) mutual funds are among the cheapest.

Figure 1: 5 Most and Least Expensive Style Mutual Funds

Investors need not pay high fees for quality holdings. BlackRock Funds iShares S&P 500 Index Fund (BSPGX) is the best ranked style mutual fund in Figure 1. BSPGX’s neutral Portfolio Management rating and 0.02% total annual cost earn it an attractive rating. Royce Small Cap Value Fund (RVVHX) is the best ranked style mutual fund overall. RVVHX’s very attractive Portfolio Management rating and 1.93% total annual cost earn it a very attractive rating.

On the other hand, Vanguard Extended Market Index Fund (VSEMX) holds poor stocks and earns an unattractive rating, despite low total annual costs of 0.12%. No matter how cheap a mutual fund, if it holds bad stocks, its performance will be bad. The quality of a mutual fund’s holdings matters more than its price.

3. Poor Holdings

Avoiding poor holdings is by far the hardest part of avoiding bad mutual funds, but it is also the most important because a mutual fund’s performance is determined more by its holdings than its costs. Figure 2 shows the mutual funds within each style with the worst holdings or portfolio management ratings.

Figure 2: Style Mutual Funds with the Worst Holdings

BNY Mellon (DMCYX, DBMYX, MPSSX) appear more often than any other providers in Figure 2, which means that it offers the most mutual funds with the worst holdings.

MSS Series Footprints Discover Value Fund (DVALX) is the worst rated mutual fund in Figure 2. Ultimus Managers Evolutionary Tree Innovators Fund (INVNX), BNY Mellon Small Mid Cap Growth Fund (DBMYX), Jackson Square SMID Cap Growth Fund (DCGTX), Berkshire Focus Fund (BFOCX), BNY Mellon Opportunistic Mid Cap Value Fund (DMCYX), BNY Mellon Small Cap Multi Strategy Fund (MPSSX), and Securian AM Real Asset Income Fund (VSDIX) also earn a very unattractive predictive overall rating, which means not only do they hold poor stocks, they charge high total annual costs.

The Danger Within

Buying a mutual fund without analyzing its holdings is like buying a stock without analyzing its business and finances. Put another way, research on mutual fund holdings is necessary due diligence because a mutual fund’s performance is only as good as its holdings’ performance.

PERFORMANCE OF MUTUAL FUNDs HOLDINGS = PERFORMANCE OF MUTUAL FUND

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