FXZ - FXZ Vs. VAW: Results Might Surprise Materials Sector Investors

2023-05-29 09:00:00 ET

Summary

• The First Trust Materials AlphaDEX® Fund ETF invests based on the StrataQuant Materials Index.
• The Vanguard Materials Index Fund ETF invests based on the MSCI US Investable Market Index (IMI)/Materials 25/50 Index.
• This article covers both ETFs and their underlying index. Afterward, I compare the ETFs for both returns and risk.
• While waiting to initiate a position might be warranted for investors fearing a US recession, I give the FXZ ETF a Buy rating between these two Materials ETFs.

(This article was co-produced with Hoya Capital Real Estate )

Introduction

This might be somewhat unusual, but I will start with why this might not be the best time to buy either of these ETFs: fear of a FOMC-induced recession. The first data is from the 2008-09 GFC market reaction.

The 2009 data also shows how an ETF's index selection can make a difference. Through the entire six-month period, Large-Cap stocks were down the least.

The COVID crash, using the 1st quarter of 2020, shows the same results.

So while waiting to initiate a position might be in order, data back to 2007 shows why Materials sector is worth a look.

This article reviews both an active-selection ETF, the First Trust Materials AlphaDEX ( FXZ ) and a passive-selection ETF, the Vanguard Materials Index Fund ETF Shares ( VAW ).

First Trust Materials AlphaDEX® Fund ETF review

Seeking Alpha describes this ETF as:

The First Trust Materials AlphaDEX Fund is an ETF launched and managed by First Trust Advisors L.P. It invests in growth and value stocks of large-cap companies. The fund seeks to track the performance of the StrataQuant Materials Index . The ETF started in 2007.

FXZ has $1.5b in AUM has a typical active-ETF fee of 61bps. The TTM Yield is 1.8%.

Index review

I found this generic description of the index set:

The StrataQuant® Indices are modified, equal-dollar weighted indices designed to objectively identify and select stocks from a particular Russell 1000® sector that have the potential for greater capital appreciation. The Indices utilize the AlphaDEX® screening methodology by applying it to each of the sectors within the Russell 1000® Index. At each rebalance, the stocks within the Russell 1000® are split into their respective sectors and are assigned a selection score utilizing the AlphaDEX® methodology. The top 75% of stocks of each sector is included in the Index. For each sector, that 75% is then split into quintiles, based upon each stock’s AlphaDEX® selection score. The top quintile receives a 5/15 (33.33%) weighting, with successive quintiles receiving weightings of 4/15 (26.67%), 3/15 (20.00%), 2/15 (13.33%) and 1/15 (6.67%), respectively. Stocks are equally weighted within each quintile.

Source: NYSE.com indices

The Materials index holds 38 stocks. They did provide a 10-year chart.

FXZ holdings review

FXZ basically holds chemical and metals/mining stocks, with a little of two other industries in the pot.

With under 40 holdings, here is the complete listing.

The Top 10 holdings are just over 41% of the portfolio's weight; the bottom 19 still comprise almost 29%: enough to affect performance. The one "Other" holding is USD.

FXZ distributions review

While FXZ has shown improvements in their payout amounts, it is not a steady upward path, but it is strong enough to earn a "B+" grade from Seeking Alpha.

Vanguard Materials Index Fund ETF review

Seeking Alpha describes this ETF as:

The investment seeks to track the performance of the MSCI US Investable Market Index ((IMI))/Materials 25/50 Index . The index is made up of stocks of large, mid-size, and small U.S. companies within the materials sector, as classified under GICS. The ETF started in 2004.

VAW holds $2.7b in AUM and being index-based has fees of only 10bps, a big advantage over FXZ. The TTM Yield is slightly more at 1.98%.

Index review

MSCI provides this index background.

The MSCI USA IMI Materials 25/50 captures the large, mid and small cap segments of the USA market. All securities in the index are classified in the Materials sector according to the Global Industry Classification Standard (GICS®). The index also applies certain investment limits to help ensure diversification limits that are imposed on regulated investment companies, or RICs, under the current US Internal Revenue Code.

Source: msci.com index

MSCI provided return and risk data for the index, the US and Global markets.

Data indicates Material stocks, compared to the overall US stock market, are very cyclical as one might expect. This was also seen in the charts that opened this article and will be seen again when both ETFs are compared.

VAW holdings review

Vanguard provides more detail as to the industry classifications.

Here we see Specialty Chemicals and Industrial Gases dominate the portfolio. The top holdings show a more concentrated one than FXZ even though VAW has 3X as many stocks.

Over 51% of the portfolio is represented by these stocks, with Linde plc (LIN) dominating the whole portfolio at over 15% allocation. For VAW, the bottom half, by count, are under 8% of the weight, again showing the importance of the top holdings as they affect performance.

VAW distributions review

Somewhat more consistent than FXZ, the growth over five years has been over 10%, earning VAW an "A+" grade.

Comparing ETFs

Starting with market-cap and growth/value, we see FXZ has more focus below the Large-Cap stocks and a slant toward Value stocks.

Pulling data from various places, here are some common equity data points.

Until recently, FXZ was providing better return results.

Taking another view, this one includes some important risk measures; again with a comparison to the S&P 500 Index via the SPDR S&P 500 Trust ETF ( SPY ).

While VAW has an edge on risk, it is not enough to overcome its lower CAGR as shown by the Sharpe and Sortino ratios.

Here is how both ETFs are viewed by Seeking Alpha's Quant ranking system; neither overly favorable with VAW slightly preferred.

Portfolio strategy

While not a fan of market timing (partly because I am so bad at it), pushing the pause button on these ETFs makes sense based on past results if one has confidence that FOMC actions will result in a US recession, or our leaders do it by failing to pass a debt ceiling bill. If a recession happens, I showed above what past ones resulted in. The next chart shows how both ETFs and SPY did after the market bottom in 2020. It shows the next 12-month results.

Final thoughts

As of today, the debt ceiling talks are moving at a glacial pace, with both sides limiting their compromises, probably knowing their base won't accept more even at the risk of defaulting and causing what is predicted to be "bad times". So while waiting to initiate a position in First Trust Materials AlphaDEX might be warranted for investors fearing a US recession, I give the FXZ ETF a Buy rating between these two Materials ETFs.

Part of any good due diligence would be comparing Materials ETFs against other sectors that either do well in a recession or long-term. I recently reviewed an ETF in both Health Care and then Consumer Staples , two other sectors with good long-term performance.

For further details see: