How to Find the Best Sector Mutual Funds 4Q16

Finding the best mutual funds is an increasingly difficult task in a world with so many to choose from. How can you pick with so many choices available?

Don’t Trust Mutual Fund Labels

There are at least 238 different Financials mutual funds and at least 682 mutual funds across ten sectors. Do investors need 68+ choices on average per sector? How different can the mutual funds be?

Those 238 Financials mutual funds are very different. With anywhere from 59 to 547 holdings, many of these Financials mutual funds have drastically different portfolios, creating drastically different investment implications.

The same is true for the mutual funds in any other sector, as each offers a very different mix of good and bad stocks. Consumer Staples funds rank first for stock selection. Energy funds rank last. Details on the Best & Worst mutual funds in each sector are here.

Paralysis By Analysis

We think the large number of Financials (or any other) sector mutual funds hurts investors more than it helps because too many options can be paralyzing. It is simply not possible for the majority of investors to properly assess the quality of so many mutual funds. Analyzing mutual funds, done with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each mutual fund. As stated above, that can be as many as 547 stocks, and sometimes even more, for one mutual fund.

Any investor focused on fulfilling fiduciary duties recognizes that analyzing the holdings of a mutual fund is critical to finding the best mutual fund. Figure 1 shows our top rated mutual fund for each sector.

Figure 1: The Best Mutual Fund in Each Sector

Sources:   New Constructs, LLC and company filings

Amongst the mutual funds in Figure 1, Vanguard Financials Index Fund (VFAIX) ranks first overall, Putnam Global Health Care Fund (PHSYX) ranks second, and Fidelity Computers Portfolio (FDCPX) ranks third. Tortoise Select Opportunity Fund (TOPIX) ranks last.

How to Avoid “The Danger Within”

Why do you need to know the holdings of mutual funds before you buy?

You need to be sure you do not buy a fund that might blow up. Buying a fund without analyzing its holdings is like buying a stock without analyzing its business and finances. No matter how cheap, if it holds bad stocks, the mutual fund’s performance will be bad. Don’t just take our word for it, see what Barron’s says on this matter.

PERFORMANCE OF FUND’S HOLDINGS = PERFORMANCE OF FUND

If Only Investors Could Find Funds Rated by Their Holdings…

Our mutual fund ratings leverage our stock coverage. We rate mutual funds based on the aggregated ratings of the stocks each mutual fund holds.

Vanguard Financials Index Fund (VFAIX) is not only the top-rated Financials mutual fund, but is also the best fund out of the 682 sector mutual funds that we cover.

The worst mutual fund in Figure 1 is Tortoise Select Opportunity Fund (TOPIX), which gets a Dangerous rating. One would think mutual fund providers could do better for this sector.

This article originally published on November 11, 2016.

Disclosure: New Constructs receive no compensation to write about any specific stock, sector, or theme.