Danger Zone 8/7/13: American Century Capital Small Cap Value Fund (ACSCX)

Check out this week’s Danger Zone Interview with Chuck Jaffe of Money Life and MarketWatch.com.

American Century Capital Portfolios, Inc: Small Cap Value Fund ACSCX is in the Danger Zone this week. ACSCX is bad news for investors from almost any angle. ACSCX has extremely high fees, low quality holdings, and a significant portion of its holdings are not consistent with its stated style exposure.

ACSCX is the worst-rated fund in the Small-Cap Value style, which itself is the worst ranked fund style in my 3Q13 style rankings report. ACSCX gets my Dangerous portfolio management ratingbecause itallocates 48% of its assets to Dangerous-or-worse stocks compared to just 8% in Attractive-or-better stocks. ACSCX’s failure to allocate more to Attractive-or-better stocks is troubling as there are plenty (14% of the market cap) of stocks in the Small-Cap Value style that earn an Attractive or Very Attractive rating.

ACSCX’s overall rating moves from Dangerous to Very Dangerous due to its abnormally high total annual costs of 5.3%. ACSCX is the 48th most expensive mutual fund out of the 6,617 I cover. Normally such high costs lead to lower assets under management. No other fund ranked in the top 50 according to costs has more than $150 million under management. However, ACSCX has over $2 billion in assets. ACSCX’s costs, in the form of a high front-end load and significant transaction fees, are less apparent than those for a fund with just a high expense ratio.

For such high costs, one would expect a huge amount of value added in the stock picking of ACSCX. It should be significantly different from the iShares Russell 2000 Value ETF IWN, its benchmark. Instead, ACSCX’s top holding is, wait for it… IWN. Investors are paying high fees only to have the fund invest 2% of assets in IWN and another 1% in a money market fund. Only four out of ACSCX’s 300 other holdings constitute more than 1% of its portfolio.

Among its other holdings, ACSCX has many that do not fall under the realm of “value” stocks by almost any measure. For instance, Compass Minerals CMP has a price to earnings ratio of 26 and a price to book ratio of over 5. My DCF model shows that CMP would need to grow after tax profit (NOPAT) by 8% compounded annually for 12 years to justify its current valuation. CMP cannot realistically be described as a “value” stock at its current price, which is already down 17% over the past week.

With a PE of 30 and a price/book ratio of 85, Entravision Communications Corp EVC is another questionable “value” stock. It is also one of my least favorite stocks held by ACSCX and earns my Dangerous rating. EVC’s financials are a mess. Its revenues are down over the past 10 years. Its debt and deferred tax liabilities are almost equal to its market cap. The company has $810 million in accumulated asset write-downs (230% of net assets). Despite these poor fundamentals, EVC is priced for significant growth. To justify its valuation of ~$5.50/share, EVC would need to grow NOPAT by 17% compounded annually for 10 years.

ACSCX’s impressive track record of performance has probably helped it attract investors. The fund is up 35% over the past year, slightly outperforming IWN. As I wrote in a recent article, past performance is not useful for predicting future performance as high achieving fund managers rarely sustain good performance. My analysis of ACSCX’s costs and holdings suggests that it will likely underperform going forward.

There are other classes of the American Century Small Cap Value Fund with lower costs, but even the cheapest one still earns a Dangerous rating. Investors should not have to pay high fees for a fund that holds poor stocks, an index ETF, and companies that fall outside of its stated purpose. Don’t be fooled by past performance. If making money in the stock market was as easy as looking at last year’s returns, we would all be rich. Due diligence reveals that ACSCX is a bad choice for investors.

Sam McBride contributed to this report

Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme.