Why talk about value mutual funds on this site?

  • Not everyone has the capital to diversify with stocks – While our primary goal is to help investors improve their analytical skills and their investment process, there is a large portion of the investing public that either prefers to let others manage their money or do not have enough fund to properly diversify. The purpose of this section of the website is to help investors find value oriented mutual funds that we believe possess the process and methodology and mindset to provide investors with reasonable returns without undue risks
  • Idea generation– We are constantly looking for new investment ideas and value oriented mutual funds is always a great place to start. There are numerous sites which track the changes in a fund’s positions. We are always looking at the changes in positions for ideas.
  • Some funds explain in detail their rationale for an idea or their investment process, which helps learning process.-  We have listed a number of mutual funds that provide their shareholders with more than just the basic summary of their fund’s performance and a brief description of what stocks impacted the fund’s performance over a given period of time. While we may not always agree with the stocks that are invested in as a result of their process or analysis, we do find several mutual fund companies spread a good deal of time explaining their process and provide real-time analysis of some ideas. This helps the learning process and provides food for thought and may challenge the investor to rethink part of his process or analysis.

Why do we need another list of mutual funds? There are already lots out there.

  • Most ranking systems are mechanical or quantitative. We acknowledge that there are probably hundreds of places to find mutual fund rankings, from Morningstar and Forbes, to newsletters and bloggers. However, we have found that almost all of these sources use quantitative methods with very little qualitative analysis of the portfolios or how past performance was generated. We believe that the same analysis methods we use to find stock with the potential to provide superior risk adjusted returns in the long run, can be applied to mutual funds as well.
  • All value funds are not the same. Just taking a cursory look at the top 25 holdings of many of the highly ranked or larger “value” funds shows that there is a wide range of definitions for “value investing”.  Some funds use the Buffett style of buying “high quality companies at reasonable prices”. Others adhere to a low price to book or price to earnings methodology and tend to have large concentrations of bank or other financial stocks. We have always had an aversion to large exposures to bank stocks due to their inherent leverage and opaque balance sheets. Some funds have large concentrations of stocks we have little understanding of ideas we just disagree with.
  • We will try to assess risk and return by analyzing current mutual fund portfolio. We think this extra step improves investors chances of finding and staying with mutual funds that will provide a reasonable return for the risk.


When we are considering a value mutual fund for our “Like” list, we use a variety of data points as input. While we certainly look at many of the same quantitative metrics used to rank funds by others, we also look at qualitative factors that might be missed by a purely quantitative and mostly backward looking rating system. For example, due to their large exposure to low price to book bank and insurance stocks, many well known and highly ranked value funds suffered significant losses during the financial crisis.We prefer funds with as little exposure to the financial sector as possible. While there are times when financials will outperform the market and value funds that tilt that way will do well, we prefer to find funds that spend their time analyzing companies that are truly understandable through all investment cycles.

Some of the data points we like to see in funds we like.

  • Small Cap Tilt
    • We think there is more room to add value by investing in smaller capitalization companies. There is less analytical coverage, which means that in house research can really add value versus the “Street”. Large cap value funds tend to overweight financials or high quality growth companies, neither of which is the focus of this research.
  • Prefer ownership of less than 100 stocks.
    • If a mutual fund manager and his research team is really adding alpha, we would prefer to see them focusing shareholder money on their best ideas and not a lot of marginal ideas or “placeholder” ideas. While there are several value mutual funds that have very good long-term records of beating the indexes with larger portfolios (Royce Funds comes to mind), we tend to reward funds with smaller numbers of holdings.
  • Concentration of top 20 ideas.
    • Similar to the criteria above, we prefer funds with a higher concentration of assets on a smaller number of their ideas. This of course has advantages and disadvantages. Mistakes impact performance more than in more diversified funds, but that is all part of investing. These funds are more volatile than funds with only 20-25% of their assets in the top 25 names. But we do not view volatility as a risk or inherently bad. So our ratings more than likely “underweight” beta or other volatility metrics compared to more quantitative ratings.
  • Long tenure of management (10-20 years)
    • We like to see management tenure span several investment cycles to help us understand how a fund’s performance has been produced in both good times and bad. It also allows enough time to discover any “style drift” or change in investment philosophy or process. Of course, a long tenure over mediocre performance is a negative. Tenures of successful value funds tends to be longer than growth funds and some managers are in place for 15-20 years or more. That fact alone should tell investors something about the merits and sustainability of value investing.
  • Fund size
    • Since we are more interested in funds with a smaller capitalization focus, it is desirable for the fund to be less than several billion dollars and preferably, under $1 billion. This is a function of math and practicality as much as anything else. Since we want to see the fund have a significant percentage of its assets in its top ideas, yet focus on smaller capitalization companies, a fund’s large asset base can tend to be a governing factor on how much it can buy. For example, if a fund with $250 million in assets wanted to put 3% of its assets in a company with a $400 million market capitalization and float, it would have to buy $7.5 million or 2% of the company’s float. A relatively easy thing to accomplish. However, a fund with $2 billion in assets would have to buy $60 million worth of stock or 15% of the company. This would be almost impossible to accomplish and the self-generated demand in the stock would push up the stock substantially before the fund could even acquire that much stock.
  • Expense ratio
    • The less money that is taken out in expenses and fees, the more money is left for shareholders and the returns are higher.
  • Lower turnover (10-35%)
    • There are a several reasons we prefer low turnover. First, low turnover means a longer holding period which is one of our main investment principles (time arbitrage Link). Having a longer investment horizon gives a fund manager an advantage over those just looking out one or two quarters. We believe that “time arbitrage” is one of the few advantages that will always be there for patient investors. Second, low turnover is a more tax efficient form of investing. Generating long term gains lowers the tax bite and boosts returns to shareholders over time. Finally, if turnover is low, the holdings are relatively stable. This is where our form of ranking comes into play. If a fund has a turnover ratio of 80% or more, the chances of it applying most of our principles is low. There is also little value in analyzing the fund’s holdings if they are only in the fund for months, not years.
  • Low exposure to banks and other hard to analyze financials
    • One area where we most likely differ from many of our peers is our aversion to financials, especially large capitalization banks. Relative to the market, banks tend to trade at lower price to book ratios. This means that many value funds tend to be overweight the financial index for long periods of time. While there are value investors that have been successful investing in banks, we are not as confident as other investors when it comes to believing we understand all the risks on and off the balance sheet. That, combined with high leverage and a continuous need to access the funding markets, gives us pause. One thing an successful investor must understand is where is competence and advantage lies. We prefer to spend our time analyzing less complicated companies and have been successful at it for many years.
  • Valuation metrics of holdings
    • We look at the typical metrics such as price to book, price to sales and PE ratios. We also like to look at the historical growth rates of those metrics as well as sale growth. We tend to be more interested in funds that own stocks with relatively low sales growth rates, although this is subjective since many financials have large negative sales growth rates which will be skewing the numbers for years. A negative growth rate in book value may also be a sign that the fund is investing in turnarounds.
  • Cash as % of assets
    • Over time, we will discuss the in more detail our thoughts on the advantages and disadvantages of a fund holding large cash balances over long periods of time. Some purists consider holding large cash balances “market timing”, while other argue it is the result of the lack of investment ideas at certain points in time.
  • Closet benchmarking
    • Over the years, studies have started looking into a concept termed “active share”. For a more detailed description please go here. Here is a link to the study that introduced the idea. The main idea is that mutual funds that have outperformed their benchmarks tend to have portfolios of stocks that have holdings that are much different than their benchmarks.
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