SPY - FCPI: Do You Still Need Inflation Protection?

Summary

• FCPI tracks the Fidelity Stocks For Inflation Index, selecting 100 U.S. equities based on valuations and positive momentum signals. Expenses are 0.29% and the ETF has $203 million in assets.
• FCPI outperformed SPY since my April 2022 review, but not by much. More focused, but more volatile, funds like EQRR proved superior.
• However, that's irrelevant because FCPI's portfolio turned over significant in the last year. My backtesting highlights how the current iteration doubled in value since December 2019.
• Considering Index reconstitutions is critical to proper fund analysis. Currently, FCPI trades at a 6.29-point forward earnings discount to SPY, is well-diversified, and less volatile than the market.
• Readers overweighting sectors like Energy likely have no need for ETFs like FCPI and EQRR. However, if you're seeking a dedicated inflation-protection solution, FCPI is a solid choice.

Investment Thesis

Recent government data showed personal consumer spending growth of 1.8% in January, half a million jobs created, and an unemployment rate of just 3.4%, the lowest since 1969. Controlling inflation is challenging, and protection through a dedicated ETF is worth exploring. The aptly-named Fidelity Stocks For Inflation ETF ( FCPI ) is the subject of today's article. I recommended FCPI in April 2022 and, after performing reasonably well, has lost some ground to the SPDR S&P 500 ETF ( SPY ) in 2023. The result is a mediocre 1.50% outperformance over ten months.

I'm disappointed but not too discouraged, mainly because FCPI's current holdings are all high-quality stocks trading at attractive valuations. Also, Index rebalancings have transformed this once-volatile fund into one with a similar risk as the broader market. In my view, FCPI is still worth holding onto if you don't have much inflation protection elsewhere in your portfolio, and I look forward to describing why in more detail next.

ETF Overview

Strategy Discussion and Key Exposures

FCPI tracks the Fidelity Stocks For Inflation Factor Index, selecting high-quality large and mid-cap U.S. stocks trading at attractive valuations with positive momentum signals. The approach also emphasizes individual industries that do well in high-inflation environments. The Index rebalances semi-annually effective at the close of business on the third Friday in February and August. That schedule means we have a new portfolio to evaluate.

FCPI is now well-balanced across most sectors. It has 21% exposure to Technology and 19% to Health Care, followed by 8-12% in Consumer Staples, Energy, and Materials. It's less growth-oriented than the SPDR S&P 500 ETF, and with a 0.29% expense ratio, costs are reasonable for its objectives.

The ProShares Equities For Rising Rates ETF ( EQRR ) is a different way to gain inflation protection. Interest rates typically rise and fall with inflation rates, but it's a more concentrated approach. Energy, Financials, and Materials make up 83% of the portfolio. With this composition, it's unsurprising that EQRR significantly outperformed FCPI. It's also easily replicated. The graph below highlights how EQRR compared against FCPI and an equal-weight portfolio consisting of three sector ETFs: XLE , XLF , and XLB since May 2022.

As shown, the returns are close and well-correlated. My preference is to use the lower-cost sector ETFs, and that's also true with FCPI. Still, that's in the past, and FCPI's current portfolio is substantially different than before. Compared to April 2022, FCPI replaced 60/100 holdings or 58% of the total portfolio weight. Expecting past ETF performance to repeat is unreasonable, so we should evaluate the fundamentals of FCPI's current portfolio to get the most accurate picture.

Several new additions are in FCPI's top ten holdings, listed below. They include Exxon Mobil ( XOM ), CF Industries ( CF ), and General Mills (GIS). These replaced companies like Marathon Oil ( MRO ), APA Corp. ( APA ), and Olin Corp. ( OLN ), resulting in a much less-volatile fund.

To illustrate the volatility change, consider the five-year betas for the six stocks mentioned above. You may welcome these changes since analysts have nearly universally downgraded FQ1 earnings estimates for the three deletions.

Performance Analysis

FCPI launched in November 2019, so performance data is limited. However, in my previous article, I analyzed backtested data from S&P Global Indices to 1996. Feel free to read my analysis , but the main conclusion was that FCPI outperformed SPY by 6% when inflation runs above 2.50%. When inflation is below 2.50%, it underperforms by 2.25%. According to the U.S. Bureau of Labor Statistics , inflation was 6.4% for January 2023, with the next reading scheduled for March 14, 2023. Therefore, there's still some time remaining before underperformance is expected.

Since December 2019, FCPI has underperformed EQRR and SPY by 1.63% and 0.46%. You can see EQRR's higher standard deviation due to its high exposure to Energy, Financials, and Materials, while FCPI's is similar to SPY.

I don't think FCPI or EQRR are appropriate long-term holdings, so these track records may not mean much. Unless you believe persistently high inflation is the new normal, they're most suitable for short-term use. Both outperformed SPY in 2021-2022.

Even so, EQRR was the better choice, and I don't want that point lost and inadvertently steer readers into purchasing an ETF they don't need. If it's efficient inflation protection you're looking for, EQRR or sector ETFs work. For a more diversified approach that you can feel comfortable holding for longer, then FCPI is worth considering. Let's discuss why next.

FCPI Analysis

The following table highlights selected fundamental metrics for FCPI's top 25 holdings, totaling 54% of the portfolio. I've also provided summary metrics for the entire portfolio compared to EQRR and SPY.

1. FCPI's share price declined by 5.91% over the last year. However, the weighted-average price change for its current holdings was a 14.41% increase. This difference illustrates how different FCPI is and why recent ETF performance should not drive your investment decision today. Analysts who do this ignore critical differences between ETFs and individual stocks, forgetting the sometimes significant impact of Index reconstitutions.

2. FCPI's five-year beta dropped from 1.26 in April 2022 to 1.00 today, indicating a market level of risk. At least temporarily, it's an alternative to SPY, while EQRR's beta remains elevated at 1.43. I've backtested the current portfolio with semi-annual rebalancings, and it's clearly different today. On a $10,000 investment in December 2019, the current portfolio's balance grew to $20,443 compared to $13,163 for FCPI.

The primary reason is FCPI's momentum screen, placing investors in a quandary. Value investors may look at the recent performance of FCPI and declare it's underperformed, so it's a good time to buy. However, the opposite is true, as the portfolio's current holdings have an excellent recent track record. You should evaluate these results, and whether FCPI is attractive to you or not depends on whether you're a value or momentum investor.

3. I've covered hundreds of ETFs on Seeking Alpha, calculating fundamental metrics based on current holdings. One thing I've learned is that there's rarely a free lunch. Portfolios that trade at cheap valuations and have high growth rates come with sacrifices like high volatility. For those familiar with Pacer ETFs like COWZ and CALF , that's how they operate, and they can sometimes seem too good to be true. That's what we have with EQRR, and unless you're comfortable with the added volatility, I don't recommend it.

4. FCPI, on the other hand, manages a similar earnings growth rate as SPY (7.61% vs. 8.16%) but trades at just 16.49x forward earnings, a 6.29-point discount. It achieves this with good diversification and doesn't "cheat" by overweighting any particular sector. Furthermore, it's easier to find deep-value stocks when profitability screens are loose. FCPI's 9.56/10 Profitability Score, derived from individual Seeking Alpha Factor Grades, is terrific and even better than SPY's. EQRR's 8.36/10 score is weak for a large-cap fund.

Investment Recommendation

Based on January's 6.4% inflation reading, I recommend having some inflation protection in your portfolio. Using sector ETFs, particularly XLE, XLF, and XLB, is a straightforward way, as is EQRR, an ETF that's excelled over the last two years due to its concentrated focus. However, I view FCPI more positively today. The latest reconstitutions significantly altered its composition. Current investors hold a well-diversified, momentum-driven portfolio with a 6.29-point forward earnings discount compared to SPY.

In addition, FCPI has nearly the same growth and volatility as a broad-based market fund, and the superior profitability score is a bonus. In conclusion, FCPI remains a solid choice if you seek a dedicated ETF to handle your inflation-protection needs. Thank you for reading, and I look forward to discussing FCPI and other alternatives in the comments section below.

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