XMMO - XMMO: High-Turnover Portfolio Of Mid Caps

2023-11-01 04:08:42 ET

Summary

• XMMO is a high-turnover portfolio of racy mid-caps picked from the S&P 400.
• XMMO has nice liquidity and a fairly adequate 34 bps expense ratio, especially assuming its turnover.
• Investors seeking a factor-centered mid-cap fund as a substitution for IJH, MDY, etc. should shortlist this ETF as the results it has delivered since July 2019 are mostly solid.
• Alas, its ability to compete with the mega/large-cap echelon is questionable.
• Overall, precisely like in December 2022, I struggle to find a sufficient argument for a Buy rating.

The Invesco S&P MidCap Momentum ETF ( XMMO ) has a strategy based on the high-momentum component of the S&P 400 index. The previous time I covered this investment vehicle was in December 2022, when I did not find a sufficient reason for a Buy rating, predominantly because I questioned the reliability of its earnings yield, which was heavily influenced by XMMO's allocations to cyclical sectors like energy. Since then, XMMO has grossly underperformed the S&P 500 index, eking out a total return of only 2.45%.

Today's note is supposed to provide an updated factor exposure overview, touch upon its performance, and elaborate on whether XMMO's strategy deserves a rating upgrade or not.

Strategy recap: leveraging the momentum factor in the mid-cap universe

As a quick refresher, XMMO's strategy is centered on the S&P Midcap 400 Momentum Index. The factsheet has the following description of this benchmark:

The Index is composed of securities with 80 securities in the S&P Midcap 400® Index having the highest “momentum scores,” which are computed by measuring the upward price movements of each security as compared to other eligible stocks within the S&P Midcap 400® Index. The Fund and the Index are rebalanced and reconstituted semi-annually.

It is worth noting that my calculations show that XMMO has just a 23.7% overlap with the iShares Core S&P Mid-Cap ETF ( IJH ), which tracks the S&P MidCap 400 Index.

I should also remind my dear readers that XMMO had a different strategy before June 2019; the changes to the ETF lineup were announced in March 2019. As it had an entirely different focus, with the Russell Midcap Pure Growth Index being the core of its strategy, performance delivered prior to the mandate change is completely irrelevant and thus will not be taken into account in the returns analysis section.

Profound shifts in factor exposure

XMMO is a high-turnover ETF. With turnover at 129%, it is no wonder that just 10 names (17.3% weight as of October 27) we saw in the December 2022 version are still in the portfolio. The list is provided below.

Created using data from the fund

At the same time, the fund added 65 components and removed 67. The most significant addition was Jabil ( JBL ), with a 5.3% weight. As a consequence, it is now long 75 stocks vs. 77 previously.

Substantial shifts in sector allocations occurred as a consequence, as shown below.

In particular, the fund has removed all the real estate and utilities names; both sectors had single-digit weights as of December 2022. Next, energy has seen its weight cut by around 12.8%, now accounting for less than 2% of the portfolio. Materials and healthcare have also seen their weights trimmed significantly. At the same time, exposure to IT, consumer discretionary, and industrials has been boosted, with the latter remaining the major sector. Allocations to consumer staples, financials, and communication have changed only slightly.

Below are the key factor parameters for the current version of the portfolio that I have calculated using data from Seeking Alpha and the fund.

• XMMO has become a little bit heavier in large caps, which is reflected in its weighted-average market cap of $9.45 billion, which has advanced from $7.64 billion as of the previous note even despite the fund performing poorly. Combined, large caps (companies with market values above $10 billion) account for more than 30% of the portfolio (about 23% in December). Small caps are absent.
• The earnings yield has fallen to 6.5% vs. 9.55% previously. The primary reason is that the energy sector, which contributed most to the EY as of December, has fallen out of favor. At this point, assuming IJH has an EY of approximately 8.2%, XMMO is priced unattractively.
• This hypothesis is supported by the fact that just 13% of the holdings have a B- Valuation rating or better. This is critically low for the current environment.
• Regarding growth, the EPS growth rate is above 20%, mostly because of Celsius Holdings ( CELH ) and RenaissanceRe Holdings ( RNR ), which have triple-digit figures. At the same time, about 16% of the stocks are forecast to report lower EPS going forward due to margin contraction or other issues.
• A pleasant surprise is robust quality, as shown by the high single-digit Return on Assets and Return on Equity of almost 22%. Also, for a mid-cap portfolio, the share of holdings with a B- Profitability rating or better is atypically large; for context, the Schwab U.S. Mid-Cap ETF ( SCHM ) has just 74% of its net assets allocated to such stocks, which I have discussed in a note earlier this October.
• Interestingly, around 87.6% of the current holdings have a B- Quant Momentum grade or higher vs. around 65% in the December version.
• As of October 30, 58 out of 75 holdings had a positive YTD price return, with Super Micro Computer ( SMCI ) being the greatest success story with a 194% return. Crane Company ( CR ) and TKO Group Holdings ( TKO ) did not have YTD data since they were listed in March and September, respectively.
• Also, it is worth noting that XMMO's portfolio is not as volatile as investors might expect from momentum-chasing strategies, as shown by the weighted-average beta coefficients.

Performance: XMMO has an edge over IJH, lags IVV

The table below is supposed to provide an update on how XMMO has performed since the strategy change; the period assessed is July 2019 - September 2023.

Data from Portfolio Visualizer

Obviously, it does have an edge over the S&P 400-tracking fund, as shown by its much stronger annualized return and, surprisingly for a momentum strategy, lower standard deviation. Interestingly, XMMO has solidly outperformed the large-cap-heavy iShares MSCI USA Momentum Factor ETF ( MTUM ) as well, with a CAGR stronger by more than 3%. Nevertheless, all the selected ETFs failed to beat the iShares Core S&P 500 ETF ( IVV ). More specifically, XMMO underperformed it by 2.48%; the primary reason was its inability to keep pace with IVV in 2021 (16.64% vs. 28.76%) and in the first nine months of 2023 (7.76% vs. 13.11%).

Final thoughts

In sum, XMMO is a high-turnover portfolio of racy mid caps picked from the S&P 400. The ETF has nice liquidity and a fairly adequate 34 bps expense ratio , especially assuming its turnover.

I believe investors seeking a factor-centered mid-cap fund as a substitution for IJH, SPDR® S&P MIDCAP 400® ETF Trust ( MDY ), etc. should shortlist this ETF as the results it has delivered since July 2019 are mostly solid. The problem here is that they were solid by mid-cap standards, and, alas, its ability to compete with the mega/large-cap echelon is questionable. Overall, I struggle to find a sufficient argument for a Buy rating.

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