No Fooling, This ETF Is Worth Considering (BATS:TMFC)

Introduction

They are a ubiquitous presence on the Internet if one is searching for stock ideas. They are pervasive in their ad campaigns for their stock ideas and newsletters. At one time, they had their own radio show featured on NPR. For those of us who were beginning investors over a quarter of a century ago, we read their books written for the novice stock picker. They are the Motley Fool.

I was motivated to research a post seen on Reddit, where a user posited the following claim phrased as a question:

The claim of any investment company being a pump and dump scheme would be accusing them of a serious crime. I certainly would never accuse any organization of committing this type of felony without any evidence. I have never felt that The Fool pushes an agenda that was not more than trying to generate business. While it prides itself on being “foolish”, I believe they are a serious organization in keeping with its fiduciary responsibilities. It is more sensible to see if the Motley Fool has a process that is prudent and robust. There is an index based on their process. Let us study that.

The Motley Fool 100 Index

My Internet sojourn led me to discover The Motley Fool Index. It selects the 100 largest and most liquid firms that pass the following criteria:

• Domiciled in the United States
• op 150 highest-rated U.S. companies in the Fool analyst opinion database (Fool IQ)
• Daily dollar volume of at $1 million over the last three months
• Excludes ADRs, GDRs, EDRs, preferred stocks, closed-end funds, exchange-traded funds, and derivatives.
• 30% buffer is applied to reduce universe turnover.
• Top 105 stocks are ranked based on Fool IQ conviction.
• Previously eligible stocks are included if their rank is equal or better than 195.
• Inclusion in the final 100 is based on market capitalization and index continuity.
• The top 70 stocks are automatically included.
• The remaining 30 stocks are based on conviction scores.
• This is a market-weighted index.

While the index is robust, the ETF that represents the index only averages a 5.8% turnover.

Index Performance

Before I make any assessments about an ETF, I always like to study its underlying index. The main purpose is because, often, the index has a longer history than one can analyze. I compared the Motley Fool 100 index to the S&P 500. Here is the data.

Click to enlarge

Here are the hypothetical returns for a $10,000 investment since the beginning of the Fool 100 Index:

First, I like any focused index that outperforms the market. I also like it when the basic risk metrics show that higher beta (1.07) strategies are worth the extra return. As a caveat, I do not like only seven years of data. I would feel more comfortable if I had a whole 30-year cycle to analyze, so I could have a better picture of down-market performance.

About The ETF

Motley Fool abandoned mutual funds in 2021 and focuses exclusively on ETFs. The Motley Fool 100 Index ETF (BATS:TMFC) was started in January 2018 and has an average expense ratio of 0.50%. When one compares its returns since 2019 to its corresponding index, its tracking error is -0.65%. This is how sites rate TMFC as an investment:

• Morningstar – Strong Buy
• Lipper Leaders – Strong Buy
• Zacks – Buy

These are the relative returns since 2019. As one can see, the ETF based on the Fool 100 index outperforms the SPDR 500 ETF.

Click to enlarge

As part of my analysis, I would like to develop a method for evaluating ETFs. Here are the questions I would like answered.

• Performance
  • Does the underlying index or ETF outperform the S&P 500 during up markets? Yes.
  • Does the underlying index outperform the S&P 500 during down markets? No.
  • Does the underlying index or ETF have a better return/risk ratio? Yes.
• History
  • Does the underlying index or ETF have a long history through several cycles? No.
• Fees
  • Are the fees fair and reasonable to its overall performance? Yes

Based on these questions, I would rate TMFC as a “Buy” at best. I want to see a longer history to determine how it might respond during down markets. Preservation of capital becomes paramount during these times, and it is important when compared to the overall market. As for the negative mark for down markets, that becomes salient if the risk/return ratio is also less than desirable.

If you are interested in merely stealing The Fool’s homework, here are the top ten holdings for TMFC:

• Microsoft Corp. (MSFT)
• Apple Inc. (AAPL)
• NVIDIA Corp. (NVDA)
• Alphabet Inc. (GOOG)
• Amazon.com Inc. (AMZN)
• Meta Platforms Inc. (META)
• Berkshire Hathaway, Inc. (BRK.B)
• Broadcom Inc. (AVGO)
• JPMorgan Chase & Co. (JPM)
• Visa Inc. (V)

Good luck and have fun.