2024-01-15 04:50:24 ET
Summary
- Total market ETFs like SCHB offer exposure to a broad segment of the stock market but may underperform the S&P 500 Index.
- SCHB is issued by Charles Schwab Asset Management and has minimal concentration risk with approximately 2500 holdings.
- SCHB's expense ratio and number of holdings are lower compared to its peers, but it may have positive investor sentiment and inflows.
- Despite SCHB being relatively overvalued vs. the S&P500 Index, I assign a Hold rating given the fund's cost structure and exposure opportunities offered.
Investment Thesis
Total stock market exchange-traded funds (ETFs) like the Schwab U.S. Broad Market ETF ( SCHB ) are investment vehicles designed to offer exposure to a broad segment of the stock market without focusing on any one specific segment of the market, in particular. Due to their very nature, most total market ETF’s are very broad, mostly containing upwards of 500-1000 stocks in their portfolios, and are generally used as building blocks for investors' portfolios.
I am not strongly in favor of total market ETFs due to their one-size-fits-all approach. To add to this, the S&P 500 Index ( SP500 ) usually performs much better than total market ETFs over time. Particularly for SCHB, I find the ETF overvalued, making the fund susceptible to performing worse than the S&P 500 Index in cases of market volatility. However, since these ETFs are good starting points for some investors, I will still assign a Hold rating.
About SCHB
The Schwab U.S. Broad Market ETF is issued by investment services firm Charles Schwab Asset Management. The fund is designed to primarily measure the performance of large-cap U.S. equity securities. SCHB offers a simple, low-cost, and tax-efficient way to gain exposure predominantly to U.S. equities. With approximately 2500 holdings in its portfolio, SCHB has minimal concentration risk. Hence, this ETF has the potential to be utilized as the core holding of an investor’s diversified portfolio. To achieve the fund’s objective, the SCHB tracks the Dow Jones U.S. Broad Stock Market Index.
I have added a chart below that shows the Top 15 Holdings and the composition of SCHB’s Funds by categories.
In order to minimize risk, the fund allocates over 88% of its assets towards large-cap stocks, with the remaining ~12% being allocated towards mid-cap stocks and a small percentage towards small-cap stocks.
Peer Comparison
Here is how SCHB compares with some of its peers. The list below is ordered by largest-to-smallest fund in terms of Assets Managed.
As can be seen, one of the biggest draws for the entire family of total market ETFs is their rock-bottom costs for investing in them. For every $100 invested, paying a three-cent expense fee to gain exposure to U.S. markets is very cheap, allowing many investors to build long-term investment strategies using funds like the SCHB. It can also be seen that the iShares Russell 3000 ETF ( IWV ) is the smallest ETF by assets managed, despite the SCHB being the newest total market ETF to be launched. I believe expense ratios might be a reason, despite IWV giving marginally higher returns of half a percent as compared with SCHB over a five-year period.
Still, I believe most of these funds are quite similar in their characteristics. One of the other observations I will make is that these funds tend to be extremely diverse and usually contain over 1000 holdings at any given point in time. In reality, SCHB has the least number of holdings at 2458 as compared to its peers. Therefore, the risk of concentrated holdings is almost eliminated due to the sheer volume of holdings in total market ETFs like the SCHB.
To understand the similarities between these funds, I will go one level deeper and do a side-by-side comparison of their holdings. Since these total market funds have over 1000 holdings, it makes sense to look at their fund holding summaries rather than peruse through all the holdings.
Again, all funds are generally aligned in terms of sector allocations and fund capital that needs to be allocated towards sectors, giving marginal differentiation benefits of any one total market ETF vs. the other.
To illustrate the differences between these ETFs, I have also attached the fund flow charts of these ETFs to compare them with the fund flows of SCHB.
From the charts, I can see that while there have been generally positive fund flows for the larger two total market ETFs, the Vanguard Total Stock Market Index Fund ETF ( VTI ) and the iShares Core S&P Total U.S. Stock Market ETF ( ITOT ), I will note that SCHB has had some inflows of late, which may indicate a positive change in investor sentiment towards the SCHB vs. other funds.
Valuing the SCHB ETF
One of the primary reasons I am not a fan of using total market ETFs is because these ETFs usually have marginally higher premiums as compared to the S&P500. While the SCHB and related total market ETFs are generally designed to give broad market exposure, the objective is not meaningfully different from the objective of the S&P500 Index , which is designed to measure the market performance of the large-cap segment of the U.S. market.
To illustrate my point, I have added the performance of SCHB and its peers vs. the S&P 500 in previous periods. I have also added how these ETFs perform in down market periods to illustrate that these ETFs lose more than the S&P500 when volatility hits markets in terms of capital losses.
I had noted earlier how the SCHB uses the Dow Jones U.S. Broad Stock Market Index to achieve the fund’s objective of broad U.S. market exposure. To value the SCHB fund, I will use the Dow Jones U.S. Broad Stock Market Index ’s forward PE estimates and arrive at my estimate for the SCHB. Per FactSet’s estimates , the S&P500 Index trades at a forward premium of 19.5 times projected earnings per share. In contrast, the Dow Jones U.S. Broad Stock Market Index currently trades at a forward PE of 22.3. To me, this seems overvalued since it is trading at a ~12% premium to the S&P500 index’s forward PE.
Risks & Other Factors to Consider
As of writing this research note, markets are expecting around ~2% of growth in GDP in the U.S., with Goldman Sachs projecting 2.1% on a full-year basis and Morgan Stanley calling for 1.9% growth in U.S. GDP. Were GDP to surprise on the down side and/or inflation to surprise on the upside, this would call for investors to re-rate U.S. equities, bringing volatility to the markets.
Further, with 2024 being an election year, investors should expect volatility until the U.S. arrives at a decision in terms of its president. On average, election years do produce ~11% positive returns, but these results are often accompanied by volatility along the way.
Conclusion
With the proliferation of the internet and the abundance of resources available on this platform, I strongly suggest investors look towards alternatives such as SPY or others rather than focusing on broad market ETFs in the current landscape. Since the SCHB is a great starter ETF to build investor portfolios, despite the ETF trading at a premium relative to its valuation, I will move to rate this as a Hold.
For further details see:
SCHB: This ETF Looks Set To Take A Break