Picking Low-Cost Funds That Pick Winners
David Trainer
CEO of New Constructs: Novel alpha from proprietary fundamental data. Proven-superior financial models and stock ratings.
After rigorous analysis of ~7,500 mutual funds, we found a low-cost fund that successfully picks businesses with quality earnings and cheap valuations. BrandywineGlobal Dynamic U.S. Large Cap Value Fund (LMBGX) is this week’s?Long Idea.
Forward-Looking Research Reveals a Very Attractive Fund
LMBGX earns our Very Attractive?Predictive Fund Rating, after our analysis of its holdings reveals the fund has a higher allocation than its benchmark to highly profitable companies with low expectations for future profit growth baked into their stock prices. The fund’s benchmark is the iShares Core S&P U.S. Value ETF (IUSV).
We leverage our Robo-Analyst technology[1]?to drive assessment of mutual fund portfolio quality by analyzing each fund’s individual stock holdings. This uniquely rigorous approach enables us to create forward-looking?mutual fund ratings?based on the strength and valuation of the underlying businesses of the stocks held in a fund.?
Per Figure 1, LMBGX allocates 55% of its assets to Attractive-or-better rated stocks compared to just 34% for IUSV. On the flip side, LMBGX allocates just 13% of its assets to Unattractive-or-worse rated stocks compared to 27% for IUSV.
Figure 1: LMBGX Allocates Capital to Superior Holdings
Sources: New Constructs, LLC and company filings
BrandywineGlobal Dynamic U.S. Large Cap Value’s Strategy Considers Quality and Valuation
It is not by chance that LMBGX allocates to better stocks than the benchmark. LMBGX’s investment strategy utilizes a?quantitative approach?to identify stocks that “have upside potential with relatively low downside risk to the Russell 1000 Value Index”. The fund ranks stocks by a multifactor score, which incorporates the following?criteria:
Unfortunately for investors, the fund does not give specifics as to how it measures all of the criteria involved in its score. For example, the fund does not state how it measures management’s utilization of capital. We would suggest the fund evaluate a company’s return on invested capital (ROIC), since accurately assessing a company’s ROIC is an important part of any rigorous investment process, as there is a?strong correlation between improving ROIC and increasing shareholder value. Though we don’t know exactly how LMBGX evaluates management’s utilization of capital, the fund’s ROIC is higher than its benchmark.
The fund’s methodology doesn’t just look for good companies, but also considers valuation to identify good stocks. The fund’s managers rely on?price-to-earnings (P/E)?and?price-to-book (P/B)?ratios, which can mislead investors. We think the methodology could be improved by incorporating price-to-economic book value (PEBV), free cash flow (FCF) yield, and a?reverse discounted cash flow (DCF) model?to more accurately understand the expectations embedded within a stock’s current price. Despite using inferior metrics, the fund is successful in identifying stocks with expectations for future growth that are much lower than the benchmark.
Quality Stocks Drive Very Attractive Risk/Reward Rating
Figure 2 contains our detailed rating for LMBGX, which includes each of the criteria we use to rate all mutual funds under coverage. These criteria are the same for our?Stock Rating Methodology, because the performance of a mutual fund’s holdings equals the performance of the mutual fund after fees.?
Figure 2: BrandywineGlobal Dynamic U.S. Large Cap Value Fund Breakdown
Sources: New Constructs, LLC and company filings
LMBGX’s holdings are superior to IUSV (click?here?for our report on IUSV) in four of the five criteria that make up our holdings/Portfolio Management?analysis. Specifically:
The stocks held by LMBGX generate higher-quality cash flows and have lower valuations than IUSV. Market expectations for stocks held by LMBGX imply profits will only grow by 10% (measured by PEBV ratio) while the expectations embedded in IUSV’s holdings imply profits will grow by 126%.
A Closer Look at LMBGX’s Quality Holdings
Out of the 104 of LMBGX’s holdings under coverage:
领英推荐
Given its ability to identify quality companies with low valuations, it’s no wonder that 11% of the mutual fund’s assets are allocated to stocks we’ve featured as?Long Ideas. Figure 3 shows the 11 LMBGX?holdings?that are open Long Ideas.
Figure 3: Open Long Ideas That LMBGX Holds
Quality Stock Selection at Below Average Cost
LMBGX’s 0.91% total annual costs (TAC) are well below the 1.59% simple average and 1.22% weighted average of the 948 other All Cap Value mutual funds under coverage. Figure 4 shows our breakdown of LMBGX’s total annual costs, which is?available?for all of the 6,600+ funds and 900+ ETFs under coverage.
Figure 4: LMBGX Total Annual Costs Breakdown
Sources: New Constructs, LLC and company filings
The Importance of Sector and Holdings Based Fund Analysis
We offer clients in-depth reports for all the 7,500+ ETFs and mutual funds under coverage. Click below for a free copy of LMBGX’s standard mutual fund report.
Simply buying a mutual fund or ETF based on past performance?does not necessarily lead?to outperformance. Only through holdings-based analysis can one determine if a mutual fund is allocating to stocks with businesses with high earnings quality and low valuations, as LMBGX does.
Most investors don’t realize they can?already?get the?sophisticated fundamental research?that enables investors to?overcome?inaccuracies, omissions, and biases in legacy fundamental datasets. Our?Robo-Analyst technology?analyzes the holdings of all mutual funds and ETFs under coverage to avoid “the danger within.” Our diligence on holdings allows us to?cut through the noise?and find mutual funds, like BrandywineGlobal Dynamic U.S. Large Cap Value Fund (LMBGX) , with a portfolio that suggests future performance will be strong.
Build An Even Better Fund For Yourself
As we showed in?The Paradigm Shift to Self-Directed Portfolio Construction, new technologies enable investors to create their own fund without any fees while also enabling better, more sophisticated weighting methodologies. If we reallocate the fund’s holdings according to?economic earnings, our?customized fund?allocates:
See a detailed view of the quality of stock allocations in our customized fund versus LMBGX’s actual allocation?here.
This article originally published on?January 19, 2022.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
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[1]?Our Robo-Analyst technology provides?superior fundamental data, as proven in?The Journal of Financial Economics, and a?novel source of alpha.