Danger Zone: First Trust Utilities AlphaDEX Fund ETF (FXU)

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

In a recent article, Chuck Jaffe wrote that when he considers a mutual fund or ETF, he looks at the ratings of three research firms: Morningstar, Lipper, and New Constructs. Morningstar and Lipper do an excellent job of tracking past price performance, but Chuck realizes that analyzing the past is not enough To make informed decisions, investors need due diligence on the holdings of a fund.

First Trust Utilities AlphaDEX Fund ETF (FXU) is in the Danger Zone this week due to its poor holdings. FXU might not have any obvious red flags on the surface, but a look at its holdings reveals a number of stocks with the potential to blow up, including some recent features in the Danger Zone. FXU has outperformed the market this year, gaining 14%, but its poor holdings make it a ticking time bomb that could blow up at any moment.

Proof That Holdings Matter

At the end of most of my articles, I include a section warning readers to avoid funds that allocate significantly to a stock that’s in the Danger Zone that week. The performance of funds I recommended you avoid provides evidence of the excess risk of investing in funds with dangerous holdings.

On September 9, 2013, I warned investors to stay away from Morgan Stanley Institutional Small Company Growth Portfolio (MSSLX) due to its significant allocation to Angie’s List (ANGI). MSSLX was also littered with companies we would put in the Danger Zone over the next several months, including Dunkin Donuts(DNKN), NetSuite (N), MercadoLibre (MELI), and Zynga (ZNGA). ANGI has dropped 60% since then, which has helped to tank MSSLX.

In the twelve months leading up to our recommendation to avoid it, MSSLX had been up 34%, outperforming the Russell 2000 by 5 percentage points. Since my recommendation, MSSLX and the Russell 2000 have diverged. The Russell 2000 is up 12%, and MSSLX is down by the same amount.

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

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