XMHQ: Focus On Quality = Exceptional Returns

seekingalpha03-21

The Invesco S&P Midcap Quality ETF is a successful ETF with over $4 billion in assets under management.The ETF focuses on quality companies with strong returns on equity and low debt.The Fund has ...

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According to the Prospectus, the Fund generally will invest at least 90% of its total assets in securities that comprise the Index. The Index is composed of a subset of securities from another Index, the S&P MidCap 400 Index (the \"S&P 400\"), as determined by S&P Dow Jones Indices LLC (the \"Index Provider\") to have high “quality.\" According to the Prospectus, this means the following:   The Index Provider assesses a security’s quality based on the following three fundamental measures: return on equity, accruals ratio and financial leverage ratio.  Return on equity is calculated as the company’s trailing 12-month earnings per share divided by the company’s latest book value per share. Accruals ratio is computed using the change of the company’s net operating assets over the last year divided by the company’s average total assets over the last two years. Financial leverage is calculated as the company’s latest total debt divided by the company’s book value. The Index Provider assesses the quality of securities of companies in the financials or real estate sectors... based only on the return on equity and financial leverage ratio measures. In selecting constituent securities for the [u]nderlying Index, the Index Provider calculates the quality score of each security in the [S&P 400] and then selects the 80 stocks with the highest quality score for inclusion in the [u]nderlying Index.... Stocks with higher scores receive relatively greater weights.\"  [Emphasis added.] The Index is rebalanced semi-annually. The more granular details on how the portfolio managers calculate the quality score for each security are not provided in the Prospectus, and this is probably a good thing -- in some sense, this is the \"secret sauce\" of the Fund. With a 5-Star rating from Morningstar, the Fund charges a very competitive 0.25% expense ratio. Assets under management exceed $4 billion, which is solid, but not as great as one might think given the Fund's exceptional long-term performance since its inception on December 1, 2006 (more on performance below). I own shares of the Fund, believe it is a BUY, and I am buying more on pullbacks for a number of reasons, including the following: First, I am attracted to the Fund's focus on fundamental quality as described above. Second, the Fund is a nice diversifier for investors overly allocated to the AI/technology high-flyers and large caps more generally. Third, I like the Fund's high allocation to the industrials sector (above 31%), which I think will do well with global growth slowly starting to accelerate. Fourth, since its inception, the Fund has demonstrated that the methodology used to create its portfolio works, as the Fund has outperformed the S&P 500 and the S&P 400 over the 10, 5, 3 and 1-year periods as shown below. 10-Year Performance (Seeking Alpha)5-Year Performance (Seeking Alpha)3-Year Performance (Seeking Alpha)1-Year Performance (Seeking Alpha) The Fund has also performed well against its competitors, which will be discussed below. Top 10 Holdings The Fund's top ten holdings are as follows as of March 15, 2024: Manhattan Associates Inc. 4.01% William Sonoma Inc. 3.70% Celsius Holdings Inc. 3.05% Reliance Inc. 2.90% Carlisle Companies Inc. 2.75% EMCOR Group Inc. 2.58% Kinsale Capital Group Inc. 2.35% Medpace Holdings Inc. 2.33% Advance Drainage Systems Inc. 2.13% Graco Inc. 2.12% _______________________________________________ Notably, the Fund's largest holding in February, Super Micro Computer (SMCI), graduated to the S&P 500. Prior to joining the S&P 500, the position made up roughly 8% of the Fund. Sector Composition & Weightings The Fund is diversified across multiple sectors. Per its website, the top sectors as of March 18, 2024 were as follows:   Industrials 31.76%   Consumer Discretionary 15.52%   Financials 15.07%   Energy 9.67%   Information Technology 9.51%   Materials 7.87%   Health Care 5.02%   Consumer Staples 4.64%   Real Estate 0.86%   Click to enlarge I like the set-up here with material exposure to Industrials, Energy, Materials and Health Care (collectively, more than 50% of the portfolio). Moreover, while I am not a big fan of the Financials sector, the Fund is not allocated heavily to banks; instead, the Fund's allocation to financial companies is mostly asset management and insurance companies. The Fund's performance is all the more impressive given the modest allocation to Technology stocks (currently under 10%). Competitors As I have shown above, the Fund has outperformed the S&P 400 and S&P 500 during nearly every performance period. The Fund has also outperformed its mid-cap competitors that use a fundamental indexing approach. In this regard, the table below compares the performance of the Fund to the Wisdom Tree MidCap Earnings Fund (EZM) (\"EZM\") and the Franklin U.S. Midcap Multifactor Index ETF (FLQM) (\"FLQM\").     The Fund EZM FLQM   YTD 20.10% 2.33% 8.06%   2023 29.50 19.68 17.48   2022 (12.42) (12.24) (12.95)   2021 20.99 30.99 28.76   2020 26.63 5.48 15.52   2019 27.18 24.49 28.56   Click to enlarge In addition, the chart below show the aggregate performance of those same ETFs over a five-year period. The Funds is by far the leader in this regard. Competitor Comparison (5-Year) (Seeking Alpha) In short, the Fund is outperforming the classic indexes as well as the other fundamental indexes utilized by its competitors. In the table below, the three ETFs are further compared.     The Fund EZM FLQM   Management Fee 0.25% 0.38% 0.30%   Number of Holdings 82 549 208   Dividend Yield 0.60% 1.22% 1.18%   Dividends Paid Quarterly Quarterly Quarterly   Daily Volume 226,006 40,652 67,849   Rebalancing Semi-Annually Annually Semi-Annually   Click to enlarge Compared to these competitors, the Fund's management fee and daily liquidity are excellent. While its portfolio has fewer holdings than the competitor portfolios, at roughly 80 stocks, the portfolio is still plenty diversified in my view. The Fund has paid a consistent dividend since its inception and the current dividend yield is modest. Overall, the Fund's performance is impressive on both an absolute and relative basis. I am frankly surprised that the Fund has not garnered more assets given how well it has performed relative to both traditional indexes and fundamental indexes. The Fund, with its awkward ticker symbol, seems to fly under the radar of most investors. Risks The Prospectus (linked earlier) highlights the risks associated with investing in the Fund. The biggest risk, from my perspective, is that the Fund's strategy catches on and is duplicated (at scale) and for that reason, or for some other reason, the Fund stops working as well as it has over time. Since small and mid-caps have been so under the radar, however, there is not the same level of competition in the mid-cap space as there is among large cap ETFs. As far as I can tell, churning out mid-cap ETFs is not the sweet spot for asset managers in the current environment. In terms of other risks, while the Fund's performance has been exceptional, past performance is never a guarantee of future results. Do your own due diligence. Conclusion  For the reasons outlined above, the Fund is a BUY. Cheers.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2421803246"}