Traditional fund research would tell you this Mid Cap Growth fund is more attractive than its holdings indicate. Despite a seemingly sound investment methodology, analyzing the fund’s holdings reveals a portfolio that is inferior to both its benchmark and the S&P 500. Add in above-average costs and future outperformance looks unlikely. Delaware Ivy Mid Cap Growth Fund (WMGAX) is in the Danger Zone.
Forward-Looking Research Protects Investors
Most legacy fund research is backward-looking. In other words, it is based on past price performance. My fund research takes a forward-looking approach based on fundamental analysis on each individual holding.
Figure 1 shows how my forward-looking Fund Ratings compare to Morningstar
MORN
Figure 1: Delaware Ivy Mid Cap Growth Fund Ratings
Great Methodology on Paper – Not so Much in Practice
Delaware Ivy Mid Cap Growth Fund aims to invest in U.S. mid cap companies “demonstrating profitability, balance sheet strength, and attractive valuations.” More specifically, the fund manager “emphasizes a bottom-up (researching individual issuers) approach” and looks for companies that have:
- the potential for strong growth,
- increasing profitability,
- stable and sustainable revenue and earnings streams,
- attractive valuations, and sound capital structures.
The fund’s prospectus also notes the managers look at many factors, including cash flow. The managers further note in the Fund Profile that the “hyper-focused view on quality growth companies” results in holdings that rank highly in quality metrics (emphasis added) “like return on assets (ROA), return on invested capital (ROIC), net margins, debt to capitalization, and a wide economic moat.“
If such a strategy sounds familiar, it’s because my stock rating methodology is based on profitability – taking into account balance sheets, ROIC, and valuation. Furthermore, my Fund Rating methodology analyzes each holding of a fund, as the manager of Delaware Ivy Mid Cap Growth fund notes it does.
However, stating a sound methodology and successfully executing such methodology are not the same, and my rigorous holdings analysis reveals WMGAX’s stated methodology does not translate to its actual portfolio.
In reality, WMGAX invests in companies with lower ROICs, negative cash flows, and more expensive valuations than its benchmark and the S&P 500. More details below.
Holdings Research Reveals a Low-Quality Portfolio
My holdings analysis reveals that WMGAX holds lower-quality stocks than its benchmark iShares Russel Mid Cap Growth ETF
IWP
Per Figure 2, WMGAX allocates 66% of its portfolio to unattractive-or-worse rated stocks compared to 51% for IWP. On the flip side, WMGAX allocates just 3% of its assets to attractive-or-better rated stocks compared to 7% for IWP.
Figure 2: Delaware Ivy Mid Cap Growth Fund Allocates to Far Worse Stocks than IWP
Per Figure 3, my holdings analysis also reveals WMGAX’s portfolio is of much lower quality than the S&P 500, as represented by State Street SPDR S&P 500 ETF
SPY
At just 33% of its portfolio, SPY allocates significantly less to unattractive-or-worse rated stocks compared to WMGAX. On the flip side, at 15% of its portfolio, SPY’s exposure to attractive-or-better rated stocks is much higher than WMGAX.
Figure 3: Delaware Ivy Mid Cap Growth Fund Allocates to Far Worse Stocks than SPY
Given the low allocation to attractive-or-better rated stocks relative to the benchmark and the S&P 500, WMGAX appears poorly positioned to generate the outperformance required to justify high fees.
Expensive Stocks Drive Very Unattractive Risk/Reward Ratings
Figure 4 contains my detailed rating for WMGAX, which includes each of the criteria I use to rate all ETFs and mutual funds under coverage. These criteria are the same for my Stock Rating Methodology, as the performance of a mutual fund equals the performance of its holdings minus fees. WMGAX’s very unattractive rating is primarily driven by holding stocks with poor fundamentals and expensive valuations.
Figure 4: Delaware Ivy Mid Cap Growth Fund Rating Details
As Figure 4 shows, WMGAX is equal to or inferior to IWP and SPY in all five criteria that make up my Portfolio Management analysis. Specifically:
- WMGAX’s holdings have a Neutral Economic Earnings vs. EPS rating vs. Positive EE for IWP and SPY
- WMGAX’s ROIC is 13%, equal to IWP’s ROIC and lower than SPY’s (22%) ROIC
- WMGAX’s free cash flow (FCF) yield of 0% is lower than IWP’s and SPY’s at 1% and 2% respectively
- the price-to-economic book value (PEBV) ratio for WMGAX is 7.4, which is greater than the 4.9 for IWP and 4.8 for SPY
- my discounted cash flow (DCF) analysis reveals an average market-implied growth appreciation period (GAP) of 92 years for WMGAX’s holdings compared to 80 years for IWP and 61 years for SPY’s holdings
The market expects significantly higher profit growth (as measured by PEBV ratio) in WMGAX’s holdings compared to IWP and SPY’s holdings (already more profitable as measured by ROIC).
Fees Only Make Owning WMGAX Worse
At 3.42%, WMGAX’s total annual costs (TAC) are higher than 91% of the 328 Mid Cap Growth mutual funds under coverage. For comparison, the simple average TAC of all the Mid Cap Growth mutual funds under coverage is 1.62% and the asset-weighted average is 1.00%. IWP charges just 0.25%, and SPY has total annual costs of just 0.10%. Why pay higher fees for inferior stock selection?
My TAC metric accounts for more than just the expense ratio. I consider the impact of front-end loads, back-end loads, redemption fees, and transaction costs – the latter of which adds 0.05% to WMGAX’s TAC.
Figure 5 shows my breakdown of WMGAX’s total annual costs.
Figure 5: Delaware Ivy Mid Cap Growth Fund’s Total Annual Costs Breakdown
To justify charging higher fees, WMGAX must outperform its benchmark by 316 basis points annually over three years, the average holding period for all funds.
However, WMGAX 1-year and 3-year quarter-end trailing annual return has underperformed IWP by 759 and 133 basis points, respectively.
Given that 66% of assets are allocated to stocks with unattractive-or-worse ratings, and 91% are allocated to stocks with Neutral-or-worse ratings, WMGAX is likely to continue underperforming.
Get an Edge from Holdings-Based Fund Analysis Based on Superior Stock Research
Smart mutual fund (or ETF) investing means analyzing each of the holdings of a fund. Failure to do so is a failure to perform proper due diligence. Simply buying an ETF or mutual fund based on past performance does not necessarily lead to outperformance. Only thorough holdings-based research can help determine if an ETF’s methodology leads managers to pick high-quality or low-quality stocks.
Most investors don’t realize they can access superior fundamental research that enables them to overcome inaccuracies, omissions, and biases in legacy fundamental research and data. My firm’s Robo-Analyst technology analyzes the holdings of all 347 ETFs and mutual funds in the Mid Cap Growth style and ~7,300 ETFs and mutual funds under coverage to avoid “the danger within”.
Diligence on holdings allows me to cut through the noise and identify potentially dangerous funds, like Delaware Ivy Mid Cap Growth Fund, that traditional, backward-looking fund research overrates.
Easily Make Any Fund, Even WMGAX, Better
As I showed in The Paradigm Shift to DIY ETFs, new technologies enable investors to create their own funds without any fees while also offering access to more sophisticated weighting methodologies. If, for instance, investors wanted exposure to a Economic Earnings weighted version of WMGAX, the risk/reward of this custom fund would improve significantly. This customized version allocates:
- 59% of assets to neutral-or-better rated stocks (compared to 28% for WMGAX)
- 41% of assets to unattractive-or-worse rated stocks (compared to 66% for WMGAX).
Compare the quality of stock allocation in as-is WMGAX vs. my customized version of WMGAX in Figure 6.
Figure 6: Delaware Ivy Mid Cap Growth Fund Allocation Could Be Improved
Better Options for Mid Cap Growth Funds
Below I present Mid Cap Growth ETFs or mutual funds that feature an attractive-or-better rating, >$100 million in assets under management, and below average TAC:
- Franklin U.S. Mid Cap Multifactor Index ETF
FLQM
- Alpha Architect U.S. Quantitative Momentum ETF
QMOM
- Commerce Funds Mid Cap Growth Fund (CFAGX) – 1.00% TAC and attractive rating
Disclosure: David Trainer, Kyle Guske II, Hakan Salt, and Italo Mendonça receive no compensation to write about any specific stock, sector, style, or theme.
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