2023-07-26 04:02:13 ET
Summary
- Despite a solid long-term track record, SCHM has struggled recently. In 2021-2022, its returns were virtually flat, and this year's gains are only average compared to 30+ other peers.
- A key draw is SCHM's 0.04% expense ratio, the best you'll find for a mid-cap blend ETF. It's also well-diversified and competes well with products offered by iShares and Vanguard.
- Still, higher-quality ETFs like XMHQ are superior. It's more concentrated and volatile, but its fundamentals are better than SCHM's across the board, including on growth, valuation, quality, and momentum.
- Even if a concentrated investment isn't for you, IJH has the edge fundamentally, is just as well diversified as SCHM, and has a cheap 0.05% expense ratio.
- The bottom line is that SCHM doesn't stand out in the crowded mid-cap blend space, and investors should explore other options.
Investment Thesis
I first reviewed the Schwab U.S. Mid-Cap ETF ( SCHM ) in October and then in January , concluding that although its low 0.04% expense ratio is an important draw, it's proven to be a middle-of-the-pack contender in the mid-cap blend space and had uninspiring fundamentals at the time compared to others like the Invesco S&P MidCap Quality ETF ( XMHQ ). Six months later, SCHM finds itself average again, ranking #17/34 peers through June 2023, while XMHQ is #1. Still, I want to provide readers with an update on SCHM's fundamentals to help identify a possible buying opportunity, as its expense ratio is category-leading and thus very attractive for passive investors. I hope you enjoy the analysis.
SCHM Overview
Strategy Discussion and Performance Rankings
SCHM tracks the Dow Jones U.S. Mid-Cap Total Stock Market Index, selecting roughly 500 securities according to size and weighting based on free-float market cap. Reconstitutions are annual in September, and turnover is low. In my view, it's a simple mid-cap blend fund that competes with more popular funds like the iShares Core S&P MidCap ETF ( IJH ), the Vanguard Mid Cap ETF ( VO ), and the iShares Russell Mid-Cap ETF ( IWR ). Still, the cheapest ETFs aren't always the best performers. To demonstrate, consider the annual returns for the following 34 mid-cap blend ETFs between 2008-2023 (June YTD). I've included quartile rankings for select funds, including SCHM, in the bottom rows.
As shown, SCHM was a top performer several times, including in 2015, 2017, and 2018. Performance was also above average in 2012-2014 and 2019-2020. However, it's slipped in recent years. Its 19.35% gain in 2021 and 17.06% loss in 2022 meant a virtually flat return for those two years. It rebounded 10.04% through June 2023 (12.41% through July 21), but even that was only average for the category. While XMHQ has a weaker track record, it only began tracking its current Index on June 21, 2019. Its focus on quality led to much stronger returns since, as illustrated in the chart below.
SCHD Sector Exposures and Top Ten Holdings
The following table highlights sector exposures for SCHM, XMHQ, IJH, VO, and IWR.
I consider SCHM, IJH, VO, and IWR straightforward mid-cap blend ETFs, while XMHQ is more specialized. XMHQ has no exposure to Real Estate, Communication Services, and Utilities, while SCHM allocates at least some to those sectors. Simply put, SCHM is better-diversified, and together with its low expense ratio is why the ETF has amassed $10 billion in assets.
SCHM's top ten holdings total 4.98% and include Royal Caribbean ( RCL ), Fair Isaac ( FICO ), and Westinghouse Air Brake Technologies ( WAB ). Unfortunately, this view likely won't help investors understand SCHM, as there are over 500 holdings in total.
SCHM Fundamentals
A compromise between company-level and sector-level analysis is to look at SCHM's fundamentals by industry. I've listed selected metrics for the fund's top 25 below, which total 50% of the fund. For comparison, I've also included summary metrics for XMHQ, IJH, VO, and IWR in the final rows. The last time I reviewed SCHM, its Profit Score was only 6.92/10 compared to 8.15/10 for XMHQ, so let's see if that's improved.
SCHM's 6.98/10 Profit Score is about the same as before, while XMHQ's has increased to 8.37/10. Similarly, the gap has grown on EPS Revisions to 0.80 (6.62/10 vs. 5.82/10) from 0.71 (6.27/10 vs. 5.56/10). Therefore, on quality and earnings momentum, SCHM disappoints. The same applies to the other well-diversified ETFs (IJH, VO, IWR).
Investors targeting the mid-cap segment should first decide if they want a broad-based ETF or a specialized one like XMHQ. I think XMHQ's pros outweigh the cons, which are limited mainly to high concentration (77% in the top 25 industries) and potentially higher volatility, as indicated by its 1.35 five-year beta. However, SCHM looks unattractive on other metrics like growth and valuation. For example, its weighted average sales growth rate is only 8.58% compared to 8.82% for IJH. Also, it trades at 21.76x forward earnings and 19.69x trailing cash flow, about one-point more than IJH. Unfortunately, I don't see any obvious advantage except for higher estimated sales growth (10.34% vs. 9.30%).
However, compared to VO and IWR, SCHM trades at a discounted valuation and doesn't give up much growth. The reason is because of how well large caps have done this year, and as mentioned earlier, their weighted average market caps of $28 billion and $23 billion are much higher. From an efficiency perspective, SCHM makes more sense. It overlaps only 3% with the SPDR S&P 500 ETF ( SPY ) compared with 16% and 17% for VO and IWR. Still, XMHQ and IJH have 0% overlap, so they make sense, too.
Investment Recommendation
Broad-based mid-cap blend ETFs trade at relatively attractive valuations, so diversifying by size makes sense. However, I don't think SCHM is the best way to go about it, and it's important to remember that not all mid-cap blend ETFs are created equal. In the last few years, SCHM has been a third- and fourth-quartile performer, and it trades at a pricier valuation than IJH without offering any meaningful benefits on growth, profitability, or earnings momentum. Furthermore, XMHQ scores better on most fundamental metrics and has an excellent track record since it began tracking its current Index. That's the better approach and why I don't recommend readers buy SCHM. Thank you for reading, and I look forward to the discussion in the comments section below.
For further details see:
SCHM: Schwab's Mid-Cap Blend ETF Not Worth Buying