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The Invesco S&P MidCap Momentum ETF (NYSEARCA:XMMO) offers exposure to a combination of the mid-size and momentum factors wrapped in a portfolio of 77 U.S. stocks selected from the S&P 400 index. Today, I would like to assess its current factor exposure addressing positives and negatives to arrive at a conclusion on whether its value and quality mix is sufficient for a Buy rating.
Investment strategy
XMMO’s investment mandate is to track the S&P MidCap 400 Momentum Index. Constituents are selected scrupulously from the S&P 400, the barometer of the medium-size U.S. equities’ performance.
Eligible names are ranked in descending order depending on their momentum scores. To qualify for inclusion, a candidate must have a score strong enough to be in quintile one out of five. The score itself is based on the twelve-month performance (with the most recent month removed). Stocks with lower volatility have higher chances to be selected.
The index uses two parameters for weighting, namely a company’s market cap, and the momentum score, and is rebalanced biannually. More details on the selection process are available in the respective documents on the index provider’s website.
Please take notice that XMMO went through a few profound strategy recalibrations in the past. Its current index was adopted in June 2019 when it stopped tracking the Russell Midcap Pure Growth Index and changed its ticker to XMMO from PXMG, thus I will ignore the data prior to July 2019 in the performance analysis section.
In the current iteration, XMMO has a portfolio of 77 holdings, with the key ten accounting for about 26.3%. Investors who are for whatever reason skeptical about the large-cap echelon would be pleasantly surprised by the fact that XMMO has approximately 82.4% of the net assets allocated to shares in companies with market values below or equal to $10 billion. Steel Dynamics (STLD), the largest firm in the portfolio at the moment, has a market capitalization of only $18.4 billion, and its weight is just 3%. Moreover, the weighted-average market cap of the portfolio is just $7.7 billion, as per my estimates.
Compared to the SPDR MidCap S&P 400 ETF (MDY), it overweights energy, industrials, materials, and consumer staples while underweighting all other sectors, especially IT and consumer discretionary, which can be explained by the fact that the latter two have suffered from the interest rate issue and have seen their market values shrinking this year, so their momentum scores are obviously bleak and the fund ignored most of them. Meanwhile, energy stocks, primarily oil & gas exploration & production names regardless of size, have been on a tear owing to the oil price rally on the back of geopolitics and the resulting supply/demand concerns, thus they account for a solid share.
Created by the author using data from the funds
For investors who would likely riposte here that the crude prices have not been that strong in the previous months, I should mention that the index was rebalanced in September (the next rebalancing is due in March), so nine oil & gas names have qualified for inclusion principally because of the robust hydrocarbon price performance in the first half of the year.
Assessing value and quality
For a momentum ETF, one should expect overstretched multiples, which is surprisingly not the case with XMMO, at first glance.
First, the portfolio has a rich earnings yield of around 9.6% or a Last Twelve Months P/E ratio of just 10.4x. The likely culprit of such is an attractive multiple (an about 46% discount to the S&P 500’s P/E of 19.2x and a 17.8% discount to the S&P 400’s P/E of 12.65x) is a large exposure to industrials, energy, and financials, which together account for around a half of the net assets. More specifically, below-market P/Es are something inherent to the financial sector (banks, insurance brokers, asset managers, etc.); to corroborate, the median adjusted P/E for the sector is currently below 10x. The two other sectors mentioned also have notably attractive earnings yields owing to their significant capital intensity which typically translates into cheaper valuations. In this regard, there is certainly no guarantee that this momentum-chasing fund remain comparatively cheap going forward in case its sector mix changes.
Delving deeper, XMMO does not look as cheap as it might seem. The share of stocks with a B- Quant Valuation grade and higher is just 20.6%, while those with D+ and lower, a worrisome level, account for almost 37%. World Wrestling Entertainment (WWE), which has a 0.9% weight, is a nice example.
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An important remark worth making is that the Quant Valuation grade is essentially a composite of a few multiples compared to the sector medians and historical averages, so it is a better indication of whether a stock is priced adequately than the earnings yield taken in isolation.
Turning to quality, a factor of paramount importance in the high interest rates era, over 78% of the holdings sport an at least B- Quant Profitability grade, a surprisingly solid result of a mid-cap equity mix. Just three companies are loss-making, namely CNX Resources (CNX), Fluor Corporation (FLR), and Alcoa Corporation (AA), with a total weight of just 3.1%. Around 2.5% of the net assets are allocated to two cash-burning companies Avnet (AVT) and NOV (NOV). All names in the mix have delivered LTM EBITDA (with the obvious exception being the financial and real estate sectors). The weighted-average Return on Equity is over 29%, as of my estimates, a solid result. Nevertheless, it is worth taking it with a grain of salt since over 35% of the holdings have a Debt/Equity ratio north of 100%, which makes the ROE figure less reliable.
Performance analysis
As I said above, most of the past performance is of no use since the fund had tracked entirely different indices. So let us look at the July 2019 – November 2022 period. The table below mixes the key metrics like the compound annual growth rate, volatility, and risk-adjusted returns measured using the Sharpe and Sortino ratios for the iShares Core S&P 500 ETF (IVV), SPDR S&P MidCap 400 ETF (MDY), and the iShares Edge MSCI USA Momentum Factor ETF (MTUM). As a brief digression, MTUM is a mega- and large-caps-heavy fund I discussed in April, with a Hold rating.
| Portfolio | IVV | MDY | XMMO | MTUM |
| Initial Balance | $10,000 | $10,000 | $10,000 | $10,000 |
| Final Balance | $14,680 | $13,810 | $14,110 | $13,361 |
| CAGR | 11.89% | 9.91% | 10.60% | 8.85% |
| Stdev | 19.61% | 23.21% | 21.05% | 20.48% |
| Best Year | 28.76% | 24.21% | 28.86% | 29.85% |
| Worst Year | -13.18% | -8.20% | -10.21% | -14.92% |
| Max. Drawdown | -23.93% | -29.63% | -22.47% | -30.16% |
| Sharpe Ratio | 0.63 | 0.49 | 0.54 | 0.47 |
| Sortino Ratio | 0.96 | 0.71 | 0.83 | 0.74 |
| Market Correlation | 1 | 0.95 | 0.9 | 0.92 |
Over that period, mostly notable for the trade war, the coronavirus pandemic, and then inflation being the major market narratives, XMMO outperformed the S&P 400 cohort, delivering a lower standard deviation, which is likely the consequence of a low volatility ingredient touched upon above. Its risk-adjusted returns are stronger as well, with a caveat that it still failed to outperform the racier S&P 500 ETF over the period discussed despite a stronger 2022.
Investor takeaway
In sum, XMMO does not deserve a Buy rating at this juncture.
First, it does have a higher earnings yield than the SPDR Portfolio S&P 500 ETF (SPLG) and MDY. Having said that, with almost 50% of the net assets allocated to cyclical capital-intensive sectors, the EY is barely the best metric to assess valuation, and the share of stocks with a B- Quant Valuation grade or higher is too small for my taste. And second, though the quality is comparatively strong, without a comfortable valuation, the mix is not attractive.
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