Long Idea: Nuveen Concentrated Core Fund (NCAFX)

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Long Idea: Nuveen Concentrated Core Fund (NCAFX) by Kyle Guske II, New Constructs

The only justification for mutual funds to have higher fees than ETFs is “active” management that leads to out-performance. The only way to outperform is to hold higher quality stocks. This week’s Long Idea, Nuveen Concentrated Core Fund (NCAFX) justifies its fees through significantly better stock selection. In fact, NCAFX allocates heavily to stocks on June’s Most Attractive Stocks list.

NCAFX combines a mix of high earnings quality companies, stocks with low market expectations, and charges low total annual costs to earn our Very Attractive predictive rating, and ranks in the 94th percentile of over 7000 mutual funds under coverage.

Nuveen Concentrated Core Fund – High Quality Holdings Make Outperformance More Likely

Nuveen Concentrated Core Fund investors get stock selection that is better than the benchmark, the State Street SPDR S&P 500 ETF (SPY).

Per Figure 1, Nuveen Concentrated Core Fund allocates 40% of capital to Attractive-or-better rated stocks compared to just 28% for the benchmark. Better yet, NCAFX allocates to some of our best rated stocks: 15% of assets to Ford Motor Company (F), Target Corporation (TGT), and Southwest Airlines (LUV). Each of these stocks is on June’s Most Attractive Stocks list.

On the flip side, NCAFX allocates less capital to Dangerous-or-worse rated stocks (14%) than SPY (34%). In fact, NCAFX does not allocate to any stock that receives a Very Dangerous rating.

Figure 1: Nuveen Concentrated Core Fund Portfolio Asset Allocation

Sources: New Constructs, LLC and company filings

Overall, five of NCAFX’s top 10 holdings (including Ford) make up 26% of its allocation and receive our Attractive-or-better rating

The price-to-economic book value (PEBV) ratio for the S&P 500 (as measured by SPY) is 2.7. The PEBV ratio for NCAFX is 2.4. This ratio means that the market expects the profits for the S&P 500 to increase 270% from their current levels versus 240% for NCAFX. In other words, expectations for profit growth in stocks held by NCAFX are lower than the overall market.

Our findings are the same from our discounted cash flow valuation of the funds’ holdings. The growth appreciation period (GAP) is 24 years for the S&P 500 and only 15 years for NCAFX. Essentially, the market expects the stocks in the S&P 500 to earn a return on invested capital (ROIC) greater than the weighted average cost of capital (WACC) on new capex for 9 years longer than the stocks held by NCAFX.

With high quality holdings, investors in NCAFX should expect outperformance over the benchmark, and therefore justification for higher fees.

Total Annual Costs Are Below Average

With total annual costs (TAC) of 1.27%, NCAFX charges more than its ETF benchmark, which charges total annual costs of only 0.10%. However, NCAFX charges below the average of all style mutual funds, which is 1.93%, and on par with the weighted average TAC of 1.26%.

To justify its higher fees, the Nuveen Concentrated Core Fund must outperform its benchmark by 1.17% annually.

Prior to 2016, NCAFX had achieved this outperformance, as can be seen in Figure 2. The bottom line is that with better holdings, we think NCAFX has an excellent opportunity to outperform its ETF benchmark moving forward.

Figure 2: Nuveen Concentrated Core Fund Growth of $10,000
Nuveen Concentrated Core Fund, NCAFX
[drizzle]Sources:   New Constructs, LLC and company filings.

The Importance of Proper Due Diligence

If anything, the analysis above shows that investors have failed to identify NCAFX as a quality investment, as exhibited by the funds low $117 million assets under management (AUM). Without analysis into a fund’s holdings, investors risk putting their money in funds that are more likely to underperform, despite having better options available such as NCAFX.

This article originally published here on June 2, 2016.

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, style, or theme.


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