XSMO - XSMO: Best In Small-Cap Growth Class

2024-01-05 10:30:00 ET

Summary

• The Invesco S&P SmallCap Momentum ETF is ranked #1 by Seeking Alpha's Quant Ranking system.
• The ETF invests in momentum stocks of small-cap companies and seeks to track the performance of the S&P SmallCap 600 Momentum Index.
• XSMO has outperformed other similar ETFs over the past decade and earns a Buy rating as a superior Growth stock strategy.

Introduction

While Small-Cap Value stocks historically have outpaced their Growth siblings, using a Momentum factor, the Invesco S&P SmallCap Momentum ETF (XSMO) is ranked #1 by Seeking Alpha's Quant Ranking system for those still wanting SCG exposure.

This article covers the ETF and its underlying Index. When viewing XSMO as a superior Growth stock strategy, as its results show for the past decade, then the ETF earns a Buy rating.

Invesco S&P SmallCap Momentum ETF review

Seeking Alpha provides this description of the ETF:

The Invesco S&P SmallCap Momentum ETF is managed by Invesco Capital Management LLC. It invests in public equity markets of the United States. The fund invests in stocks of companies operating across diversified sectors. The fund invests in momentum stocks of small-cap companies. It seeks to track the performance of the S&P SmallCap 600 Momentum Index . The fund generally will invest at least 90% of its total assets in securities that comprise the underlying index. XSMO started in 2005.

Source: seekingalpha.com XSMO

XSMO has $277m in AUM and comes with 39bps in fees. The yield is only .95%, so income investors must look elsewhere.

Index review

S&P Global describes its Index as:

The S&P SmallCap 600® Momentum Index is designed to measure the performance of securities in the S&P SmallCap 600 universe that exhibit persistence in their relative performance.

Source: spglobal.com index

The Index Methodology document goes into detail on the calculations used; I present the critical ones.

This is then fed into the next calculation that helps reduce the influence of outlier data points. There are also maximum weight restrictions.

I barely passed pre-calculus fifty years ago, so I will pass on trying to explain the above other than to say it is the guts of the selection process and I approve it in concept.

Holdings review

I included the sector weights for the two ETFs I use later for performance comparison, as this indicates how the momentum strategy alters those allocations.

Between XSMO and IJT, the indexed SCG ETF, there are five sectors where the allocation shift is over 3%, plus XSMO holds no Utilities stocks at this time. Related to that, the two biggest underweights are in sectors that are interest-rate sensitive, Financials and Real Estate. With the recent FOMC indications, I would expect that to change after the next rebalancing in March. The largest overweight is in Consumer Discretionary, stocks that would do well without a recession occurring in 2024.

Top holdings

These stocks comprise 41% of the total portfolio, though XSMO currently holds 111 stocks, less than the targeted 120. It takes the smallest 30 positions to equate to 10% of the portfolio; again indicating how dependent XSMO is on the top holdings. Since the weighting is based on the momentum score, this is what I would expect. An example of how the weighting plays a role, e.l.f. Beauty ( ELF ) is the top stock in both XSMO and IJT, but the weight here is over 3X IJT's weight. Granted some of that is due to IJT holding over 300 stocks.

Distributions review

Consistent income to investors is not a feature of this ETF and there doesn't seem to be an obvious payout correlation to how well the economy is doing either. It is then no surprise that Seeking Alpha gives this pattern a D+ grade.

The growth rates should not be taken lightly considering the roller coaster ride payout levels have been on.

Portfolio strategy

Whenever I evaluate a factor-based ETF like XSMO, the first test is comparing its performance against the plain vanilla indexed ETF that uses the same set of stocks that the factor-based ETF used. Here, I chose two for that purpose:

• • iShares Core S&P Small-Cap ETF ( IJR )
  • iShares S&P Small-Cap 600 Growth ETF ( IJT )

IJR represents the SC base index; IJT the SC growth index, since XSMO is classified as a Growth ETF. IJT's allocation between Growth/Value aligns well against XSMO's allocation, justifying its usage here.

With a big exception with the 3-year CAGR versus IJR, over the past decade, XSMO was the best-performing of the three ETFs. Using data back to 2005 though, has XSMO in a distant third place. Different investors value which time period they prefer, though I would think momentum investors prefer the near-term in deciding to buy or sell this ETF. The point is that momentum investing isn't a perfect strategy, just like every other strategy isn't. That said, compared to the SCG ETF, XSMO has a higher CAGR at each of the shown time periods. Currently, XSMO's Seeking Alpha ETF grade for momentum is an A+, increasing in each of the displayed measuring periods.

When viewing XSMO as a superior Growth stock strategy, as the results show for the past decade, then the ETF earns a Buy rating.

Final thoughts

XSMO drives its success off momentum. The underlying index is rebalanced semi-annually, effective after the close on the third Friday of March and September, using data gathered from the last business day of February and August. While that gives time for the selection factors to prove themselves, it also limits the times the index is updated with more current data; something to consider. I employ some factor ETFs in my allocation to offset all the index-based (read market matching) ETFs with the desire to pick up some Alpha. Being retired, conservative, and financially sound, a little is all I feel I need.

While Large- and Mid-Cap stocks have outperformed Small-Cap Growth stocks since 1972, without the last five years, that performance gap is small. That said, SCG stocks show a .84 correlation to LCG stocks and a .92 factor to MCG stocks, providing another reason to have some allocation to this market-cap sub-sector.

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