(This article was co-produced with Hoya Capital Real Estate)
I have been doing a series of articles exploring various Exchange-Traded-Funds, or ETFs, that invest in the Mid-Cap space of the US stock market. The first article, Thanks To Put Writing, I Own VXF; So A New Review Was In Order, which invests in both Mid-Cap and Small-Cap stocks, and then a follow-up article that showed focusing on just Mid-Cap stocks was worth taking a deeper dive into.
My first comparison article paired the SPDR S&P MidCap 400 ETF Trust (MDY) and the iShares Russell Mid-Cap ETF (IWR) as they invest based on well known and highly followed indices. Here, I will compare two ETFs that use less familiar indices: Schwab U.S. Mid-Cap ETF (SCHM), which uses the Dow Jones U.S. Mid-Cap Total Stock Market Indexand the iShares Morningstar Mid-Cap ETF (IMCB), which invests based on the Morningstar US Mid Cap Index.
With Big Tech ruling the US market over the last decade, why worry about Mid-Cap stocks is a good question. The answer is based on the market returning to its historical pattern of rewarding investors for taking more risk, which most pundits would say happens when investing in smaller stocks.
Since 1972, Mid-Cap stocks have provided the best CAGR, Sharpe and Sortino ratios. The higher StdDev than Large-Cap stocks confirms they are risker by that measure. In theory, Small-Caps should have the best returns, and occasionally they did since 1972.
Exploring the Schwab U.S. Mid-Cap ETF
Seeking Alpha describes this ETF as:
Schwab U.S. Mid-Cap ETF is an exchange traded fund launched and managed by Charles Schwab Investment Management, Inc. It invests in public equity markets of the United States. The fund invests in stocks of companies operating across diversified sectors. It invests in growth and value stocks of mid-cap companies. The fund seeks to track the performance of the Dow Jones U.S. Mid-Cap Total Stock Market Index. SCHM started in 2011.
Source: seekingalpha.com SCHM
SCHM has $9.8b in AUM and currently yields about 1.16%. Schwab only charges 4bps in fees, a level becoming more expected by investors for passive ETFs. Currently, SCHM is the only ETF based on the Index they picked.
Understanding the Index
S&P Dow Jones has a very simple definition of their Dow Jones U.S. Mid-Cap Total Stock Market Index:
The index, a member of the Dow Jones Total Stock Market Indices family, is designed to measure the performance of mid-cap U.S. equity securities.
Source: spglobal.com Index
These Rules and Characteristics provide flavor to that description:
- Stocks: Currently is 504
- The index is a sub-index of the Dow Jones U.S. Total Stock Market Index
- The primary listing must be on an eligible U.S. exchange. Common stocks and REITs are eligible
- The Index consists of 500 stocks selected using the following buffer rules: Current mid-cap index constituents ranked between 401 and 1,100 remain in the index. If the index does not contain 500 stocks after applying the buffer, remaining places in the index are taken by the largest non-constituent stocks ranked 501 or smaller are added until 500 stocks are included
- Weighting Method: Float-adjusted market cap weighted
- Annual Reconstitution: Annually in September
- Rebalancing Frequency: Quarterly in March, June, September, and December
- Max Market Cap: $34,235.89
- Min Market Cap: $ 57.73
- Mean Market Cap: $8,995.25
- Median Market Cap: $7,967.16
It is important to point out the sectors are not based on the more well-known GICS coding, but their own, which elsewhere is listed the Industry Classification Benchmarkor ICB, a Down Jones/FTSE joint venture.
SCHM Holdings review
Unlike many Large-Cap ETFs, while still the largest sector exposure, Technology stocks hold 10% less weight here than what an ETF like SPDR S&P 500 Trust ETF (SPY) holds. Sector allocations have a great influence on performance of an ETF, more so than asset size should. SCHM assets are 76.4% between $3-15b in market-cap, 23.5% between $15-70b and a fractional amount below $3b.
The top 10 represent about 10% of the assets. SCHM currently hold just over 500 stocks. What’s surprising in no stock from Industrials or Consumer Cyclicals are on this list as those sectors are #2 and #3 in allocation. That equates to those sectors having more or the smaller market-cap stocks than other sectors do.
SCHM Distribution review
SCHM pays dividends quarterly, payable in the last month of the quarter. Seeking Alpha shows the payouts having a 5% CAGR over the 3- and 5-year periods. Overall, they give SCHM a “B-” dividend grade.
Exploring the iShares Morningstar Mid-Cap ETF
Seeking Alpha describes this ETF as:
iShares Morningstar Mid-Cap ETF is an exchange traded fund launched by BlackRock. It invests in stocks of companies operating across diversified sectors. It invests in growth and value stocks of mid-cap companies. The fund seeks to track the performance of the Morningstar US Mid Cap Index. IMCB started in 2004.
Source: seekingalpha.com IMCB
IMCB is much smaller than SCHM at only $873m in AUM. Yield (1.15%) and fees (4bps) match the other ETF.
Understanding the Index
Morningstar describes their Index as:
The index measures the performance of US mid-cap stocks. These stocks fall between the 70th and 90th percentile in market capitalization of the investable universe. In aggregate, the Mid-Cap Index represents 20 percent of the investable universe. This Index does not incorporate Environmental, Social, or Governance (ESG) criteria.
Rules and characteristics include:
- Security must be a common stock, REIT, or tracking stocks.
- Security must trade on one of the three major U.S. exchanges.
- Securities with more than 10 nontrading days in the prior quarter are excluded. Low liquidity stocks (lowest 25%) are also excluded.
- The index is reconstituted semiannually and implemented after the close of business on the third Friday of June and December.
- The index is rebalanced quarterly and implemented after the close of business on the third Friday of March, June, September, and December and is effective the following Monday.
The following Mid-Cap criteria is then applied for this Index:
- Among the stocks that fall between 70% and 71% of the investable universe (the lower end of the large-cap/mid-cap buffer zone), those that were classified as large cap and ranked within the top 70% of the capitalization of the U.S. equity market at the previous reconstitution date are reassigned to the large-cap band. The rest are assigned to the mid-cap band.
- Selecting from the remaining stocks by size in descending order, the stocks that fall between 71% and 89.5% of the investable universe are assigned to the mid-cap band.
- Among the stocks that fall between 89.5% and 90% of the capitalization of the investable universe (the upper end of the mid-cap/small-cap buffer zone), those that were classified as small cap and ranked below 90% of the capitalization of the investable universe at the previous reconstitution date are reassigned to the small-cap band. The rest are assigned to the mid-cap band.
I will review sector data when the two ETFs are compared later.
IMCB Holdings review
Like SCHM, Technology is the biggest sector allocation, again about 10% less than what SPY holds. I will compare sectors with SCHM later.
Out of about 570 stocks, the Top 20 represent just over 9% of the assets. Unlike SCHM, all the top sectors make this list although the sites label the sectors differently.
IMCB Distribution review
IMCB also pays dividends in the last month of each quarter. Seeking Alpha rates IMCB as a “B+” overall for dividends, but I am baffled as to how when seeing the detail.
Comparing the ETFs
Let’s start the comparison by looking at how the sector allocations match up.
Seven sectors differ by over 1% in their sector weight, which compared to some pairs of ETFs is not that large. My belief is SCHM will do better as interest rates rise as they hold more Financials and less Utilities than IMCB does. The two seem closely matched for a growing economic environment with SCHM overloading Consumer Discretionary and Industrials and IMCB having a larger allocation to Technology and Energy stocks.
The same site shows they have a 36% overlap in total weight, with 310 stocks being held by both ETFs. Another measure is 64% of SCHM’s stocks are held by IMCB; 56% in the reverse direction.
The next chart shows the largest overweights by individual holdings for each ETF.
As I saw in a prior comparison, the overweights dominate the Top 10 holdings of each ETF, with seven of SCHM’s list appearing here and the biggest eight for IMCB all appear on their Top 10 list. It might be just me, but there is one glaring difference in these two lists. I only recognize four of the names on the SCHM list, but all but the top one on the IMCB list. For both ETFs, 8 of the Top 10 appear in the respective lists of the most overweight differences.
One purpose of looking at these common equity ratios is to see if the underlying Index gives its respective ETF a Growth or Value tilt. While there seems to be more Growth versus Value for IMCB, the ratio differences are not enough to label either ETF as being dominate in either classification.
Using several search functions, I found over a dozen ETFs that invest in the Mid-Cap space; 40 CEFs, and over 550 Mutual Funds. That is a lot of funds to potentially research; only a fraction have articles on the Seeking Alpha platform currently. Of course a top-notch searching tool will allow you narrow the universe based on criteria you might have already decide on, like:
- Must be a certain fund type: ETF, CEF or MF
- Must be a select set, or only one, sponsor
- Must be a pure Mid-Cap fund, not Growth/Value or other strategy like Equal-Weight or Dividend-focused
- To blend in with my Large- and Small-Cap funds, it must be an index from a certain provider, such as S&P or Russell
Here is a list of some of the most popular Mid-Cap ETFs on Seeking Alpha. It is a blend of Mid-Caps based on various Indices or sub-factor as mentioned above.
Green cells represent better results; pink ones were below average results. For those with 10 or more years of history, the Vanguard Mid Cap ETF (VO), reviewed recently (article), bettered the non-focused competition by 60bps. The two reviewed in this article, SCHM and IMCB, were the closest in CAGR after 10 years. As with the Large-Cap stocks, the Vanguard Mid-Cap Growth ETF (VOT) was the top performer.
Thanks to the Large-Cap surge since 2018, investors owning funds with no exposure to NASDAQ 100 stocks or the large Tech companies on the NYSE have been left behind. That doesn’t mean Mid-Cap stocks do not have a place in an investor’s US Equity allocation as these stocks show a correlation to the NASDAQ stock of only 80-83%; in the mid-90s to the S&P 500 stocks.