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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.

For Investment Success, Keep It Simple

By Carl Delfeld Investing can seem incredibly complicated and intimidating, especially for the novice. There are thousands of stocks and almost as many funds to choose from, not to mention stock markets that always seem volatile and uncertain. Even tougher is deciding when and how to sell a stock or fund to lock in gains or limit losses. It helps to follow a simple strategy to help make these decisions pretty much automatically. Here are four principles that will help you get started. #1: Build a Diversified Core Portfolio Leonardo da Vinci was right when he said, “Simplicity is the ultimate sophistication.” And legendary global investor Sir John Templeton really nailed it with his sage advice, “Diversify. In stocks and bonds, as in much else, there is safety in numbers.” For your core portfolio, I suggest going with low-cost, tax-efficient exchange-traded funds (ETFs) as building blocks. As I describe in my book, Think Global, Grow Rich , this core portfolio has capital preservation as its primary goal and capital appreciation as a secondary goal. It’s a well-diversified portfolio with allocations to fixed income, broad U.S. equity markets, exposure to high-quality international markets, income- and dividend-oriented ETFs, gold, and even some exposure to other strong currencies – in case the dollar falls off its perch. #2: Set Aside Ample Cash After setting up a core portfolio, you should set aside a comfortable cash position of at least six months’ worth of living expenses. This is where I differ from many other advisors who want their clients to always be fully invested. Another reason to keep a lot of cash in your brokerage account is to be able to take advantage of markets and stocks when they’re on sale. You want to have the ability to move quickly and not have to figure out which stocks to sell in a hurry. #3: Seek Capital Gains With Your Explore Portfolio. Any capital you have left can go to your “explore” portfolio with the full recognition that seeking capital appreciation means higher risk and volatility. You still need some diversification in this portfolio, but you should also feel free to look at aggressive asset classes like emerging markets, commodities, sector ETFs, and individual stock ideas. One great way to gain exposure to international markets is through country-specific ETFs. With a click of the mouse, you can invest in 32 countries, such as Singapore, Switzerland, or Mexico, through the iShares MSCI Singapore ETF (NYSEARCA: EWS ), the iShares MSCI Switzerland ETF (NYSEARCA: EWL ), and the iShares MSCI Mexico Capped ETF (NYSEARCA: EWW ), respectively. Using country ETFs also gives you a hedge on the U.S. dollar weakening since. For example, when you buy the Switzerland ETF, you also gain exposure to the Swiss franc. Pick countries that are out of favor, and with time, you’ll enjoy solid gains. For individual stocks, stick to investing only in companies you understand. Invest only in what you know. Don’t just accept someone else’s opinion, do some independent homework on your own. And try to avoid complicated stories, because managing these companies is difficult and there are just too many things that can go wrong. #4: Capture Gains and Limit Losses We’ve all been there. Nothing is more painful than picking a great stock and watching it peak and then fall back to earth. Don’t ride the roller coaster with your investments. If you’re fortunate enough to have a stock or fund double in value, immediately sell half of your position to protect profits. And whenever you buy a stock, it’s smart to put in place a 20% trailing stop loss. This means you have an automatic exit if your stock falls 20% from its high. This is important, because it takes emotion out of the equation and protects your hard-earned gains, or limits your losses, so you can fight another day. It’s not a perfect approach, and sometimes that darn stock will rebound just after your stop loss strategy tells you to sell it. This is irritating, but much less painful than watching all your gains evaporate day after day, right before your eyes. Follow these four simple rules, and you’ll be way ahead of the crowd. Original Post

Oil Rally Likely To Continue: ETFs And Stocks To Watch

Oil prices have shown an impressive rally over the past week on outages and supply disruptions around the world, suggesting that the global oil market might be rebalancing faster than expected. In addition, Goldman (NYSE: GS ), one of the most bearish forecasters, gave an added boost by suddenly turning bullish on the commodity. In fact, oil prices hit a seven-month high, with crude rising to over $48.50 per barrel and Brent currently hovering near $50 per barrel. Improving Fundamentals The oil market seems to be rebalancing, with shrinking supply and rising demand. This is especially true as the massive wildfire that broke last week in Fort McMurray, Alberta, is now at the doorstep of the oil-sands mines. This resulted in the evacuation of thousands of workers and cut Canadian oil production by at least 1 million barrels a day. Clearly, this marks a massive reduction given that Canada is the world’s fifth-largest oil producer, with an average output of 4.4 million barrels of oil per day. Additionally, militant attacks and the threat of nationwide strike pushed Nigeria’s oil output to a 20-year low of 1.4 million barrels per day. Political instability and economic meltdown in Venezuela also contributed to fears of oil supply disruption. Further, oil production in China fell 5.6% year over year in April and 2.7% in the first four months of 2016, while the U.S. saw a year-over-year decline of 0.7 million barrels a day last month. Moreover, the U.S. Energy Information Administration (EIA) expects oil production from the seven shale regions – Bakken, Eagle Ford, Haynesville, Marcellus, Niobrara, Permian and Utica – to fall by 113,000 barrels a day to 4.96 million barrels a day in June from May. The agency also predicts global demand to grow on higher Chinese and Indian consumption. It expects demand to rise by 1.4 million barrels per day for this year and 1.5 million barrels per day for the next, compared to the earlier projections of 0.3 million barrels per day and 0.2 million barrels per day, respectively. Goldman Turns Bullish The unexpected supply disruption of as much as 3.75 million barrels a day and sustained demand has duly prompted Goldman to turn bullish on oil. The investment bank now believes that the two-year big oil supply glut has taken a “sudden halt” and turned to a deficit. It said “the oil market has shifted from nearing storage saturation to being in deficit much earlier than expected.” As a result, Goldman raised the price target for crude oil to $45 per barrel for the second quarter and $50 per barrel for the second half from $35 per barrel and $45 per barrel, respectively, predicted in March. However, the analyst cautioned that the market would return to surplus in the first half of 2017 on increased exploration and production activity. Diminishing “Contango” Impact The spread between the near-term futures contracts and the later-dated contracts has reduced, thereby giving a boost to oil prices. In particular, the spread between the oil futures contracts expiring later this year and similar contracts expiring in late 2018 narrowed to $1.21 from $8 in December 2015 . This reduced contango suggests that the supply glut may be falling, after years of overproduction. If this trend continues to persist going into the peak refining season, the oil market may move into a state of backwardation, where later-dated contracts are cheaper than near-term contracts. This is bullish for the commodity. ETFs to Tap While there are several ETFs to play the recent rally in oil prices, we have highlighted three funds each from different zones that are the biggest beneficiaries from this trend. Oil Futures ETFs – United States Oil ETF (NYSEARCA: USO ): This is the most popular and liquid ETF in the oil space, with AUM of $3.9 billion and average daily volume of more than 42 million shares. The fund seeks to match the performance of the spot price of West Texas Intermediate (WTI or U.S. crude). The ETF has 0.45% in expense ratio and gained 8.4% over the past five trading days. Energy ETFs – PowerShares S&P SmallCap Energy Portfolio ETF (NASDAQ: PSCE ): This fund offers exposure to the energy sector of the U.S. small cap segment by tracking the S&P Small Cap 600 Capped Energy Index. Holding 32 securities in its basket, it is highly concentrated on the top three firms with a combined 37.1% share, while other firms hold less than 6.6% of total assets. The fund is less popular and less liquid, with AUM of $52.4 million and average daily volume of about 38,000 shares. The expense ratio came in at 0.29%. PSCE was up about 5% in the same time period (see all the energy ETFs here ). Leveraged Oil ETFs – VelocityShares 3x Long Crude Oil ETN (NYSEARCA: UWTI ): This is the popular leveraged fund targeting the energy segment of the commodity market through WTI crude oil futures contracts. It seeks to deliver thrice the returns of the S&P GSCI Crude Oil Index Excess Return and has amassed over $1 billion in its asset base. It trades in heavy volumes of 12.8 million shares a day, though it charges a higher fee of 1.35% per year. UWTI surged 26.4% over the past five trading sessions. Stocks to Tap We have chosen three stocks using our Zacks stock screener that have a Zacks Rank #1 (Strong Buy) or #2 (Buy) with a VGM Style Score of “A” or “B”. The combination of these two offers the best upside potential. Murphy USA, Inc. (NYSE: MUSA ): This Zacks Rank #1 company is a retailer of gasoline products and convenience store merchandise primarily in the United States. It saw positive earnings estimate revision of 21 cents for fiscal 2016 over the past 60 days and has an expected growth rate of 42.12%. The stock has a VGM Style Score of “A”. Enbridge, Inc. (NYSE: ENB ): This Zacks Rank #2 company with a VGM Style Score of “B” is a leader in energy transportation and distribution in North America and internationally. It saw positive earnings estimate revision of 18 cents over the past two months and has an expected growth rate of 8.69% for this year. McDermott International, Inc. (NYSE: MDR ): This Zacks Rank #1 company is a leading provider of integrated engineering, procurement, construction and installation services for offshore and subsea field developments worldwide. It saw an estimate revision to 4 cents from a loss of 3 cents over the past 60 days. It has a VGM Style Score of “B”. Contrarian View While we expect the oil price rally to continue in the near term, many market experts believe the rise is temporary and that the market will again be flooded with more oil once the problem of outages is resolved. Further, Saudi Arabia and Iran are keen on increasing their output. Original Post