FMDE ETF: An Excellent All Weather ETF For Mid-Cap Investors (NYSEARCA:FMDE) #NewsETFs

Investment Thesis

The Fidelity Enhanced Mid Cap ETF (NYSEARCA:FMDE) reorganized from a mutual fund on November 17, 2023, and now provides ETF investors access to an actively managed strategy with a solid history of outperforming its benchmark, the iShares Russell Mid-Cap ETF (IWR). In this article, I will compare FMDE’s fundamentals with IWR and three other passive Index funds and explain why I believe it’s the better pick for mid-cap investors. I hope you enjoy the read.

FMDE Overview

FMDE, previously known as the Fidelity Mid Cap Enhanced Index Fund, launched on December 30, 2007. The fund is co-managed by four portfolio managers: Max Kaufmann (2009), Anna Lester (2019), Shashi Naik (2014), and George Liu (2023). The latest prospectus document states Mr. Kaufmann will retire on or around March 31, 2024. Given the absence of a revised prospectus, I assume he is still with the firm, but his retirement presents a continuity risk for the fund.

Still, the three other portfolio managers are industry veterans. For example, this announcement from Fidelity notes that Ms. Lester, prior to her current role as senior portfolio manager for Fidelity’s Systematic Equity Strategies division, was a “senior portfolio manager at Geode Capital Management, where she was responsible for managing quantitative equity funds.” Mr. Naik also previously worked at Geode Capital Management, the sub-advisor of many Fidelity funds, so I’m confident the ETF is in good hands. Besides, FMDE’s selection process appears mostly automated. From the prospectus, the fund’s principal investment strategy is:

Generally using computer-aided, quantitative analysis of historical valuation, growth, profitability, and other factors to select a broadly diversified group of stocks that may have the potential to provide a higher total return than that of the Russell Midcap Index.

Furthermore, the abovementioned announcement notes how Fidelity’s enhanced strategies aim to build a portfolio “that can outperform in a variety of market environments.” This feature is essential and differs from those employed by funds like the Invesco Russell 1000 Dynamic Multifactor ETF (CONTENTS). While OMFL’s model identifies a specific economic regime and then goes “all-in” on the factors that tend to perform well in those environments, FMDE’s “all-weather” approach brings humility to the strategy. Put differently, no analyst, computer-aided or otherwise, has all the answers, but improving the statistics on critical factors like value, growth, and quality can also increase the fund’s chances at long-term success.

Lastly, FMDE’s 0.23% expense ratio is higher than that of its passive peers. For example, IWR’s expense ratio is 0.19%, while the iShares Core S&P Mid-Cap ETF (IJH) and Vanguard Mid-Cap ETF (VO) feature fees of 0.05% and 0.04%, respectively. FMDE’s $1.85 billion AUM figure is also much lower but still sufficient, and what matters more is its track record and fundamentals. Therefore, let’s look at that next.

FMDE Analysis

Performance Summary

The following table highlights FMDE’s total returns since its inception compared to IWR, IJH, and VO. Through August 2024, FMDE and its predecessor fund gained 353.36%, about 21% and 19% better than IWR and VO. However, it lagged behind IJH by about 8%. Notably, IJH, which tracks the S&P MidCap 400 Index, has some built-in profitability screens for new entrants, which is likely why it performed best in the long run.

Despite FMDE underperforming IJH, it delivered stronger risk-adjusted returns over this period due to lower standard deviation (18.22% vs. 19.13%). In addition, its “worst month” figure of -19.90%, which occurred in October 2008, was about 2% better than these three peers. While these differences are slight, they still suggest FMDE belongs in the conversation about which mid-cap blend ETF is best.

Over the last ten years, FMDE’s 150.83% total return ranks #6/17 in the mid-cap blend category. Top performers like XMMO and XMHQ focus on a single factor and may be appropriate only under certain circumstances, but as far as broad-based strategies go, FMDE’s track record is strong.

FMDE Fundamental Analysis

The following table highlights selected fundamental metrics for FMDE’s top 25 sub-industries, totaling 57.46% of the portfolio. Although this concentration level is higher than IWR, IJH, and VO, it’s still quite low. In contrast, XMMO and XMHQ’s figures are 86.34% and 77.76%, respectively. Therefore, you give up a lot of diversification benefits when you focus only on a single factor, which adds to the portfolio’s risk should those factors fall out of favor.

Here are three additional takeaways to consider:

1. FMDE has a 1.18 five-year beta, slightly above IWR and VO. This finding is inconsistent with the lower volatility the fund realized previously, but I trust these calculations more. FMDE is a high-turnover fund, with turnover exceeding 100% in the last fiscal year. As a result, there’s an excellent chance FMDE’s holdings are substantially different than what they averaged in the previous 16 years, and you can’t expect the fund to offer much downside protection. IJH’s identical beta is worth noting, but its weighted average market cap of $9.83 billion is much less than FMDE’s $27.65 billion, and all things equal, the smaller stocks in IJH should be more volatile.

2. FMDE has an advantage over these three peers regarding earnings growth and valuation metrics. For example, its constituents grew earnings by 10.77% per year over the last three years, with analysts expecting a further 11.28% growth for the next twelve months. These figures are 1-3% better than IWR, IJH, and VO, while FMDE also features an attractive 16.90x forward P/E.

3. FMDE is a high-quality fund, evidenced by an 8.16/10 profit score, which I derived from individual Seeking Alpha Factor Grades. It also has excellent earnings momentum based on its 6.84/10 EPS Revision Score and 9.52% earnings surprise result from the last quarter. The table identifies FMDE’s Application Software stocks as top contributors to these statistics, led by Zoom Video Communications (ZM). The video conferencing company soundly beat normalized earnings expectations by 13.93% last quarter ($0.17 / $1.22) and has an “A-” Seeking Alpha EPS Revision Grade, with 31/31 analysts increasing earnings expectations over the previous 90 days.

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Investment Recommendation

FMDE is designed as an all-weather mid-cap blend ETF, and my analysis confirms its managers have done several things right. Among the 50 ETFs I track in this category, consider how FMDE ranks pretty well on most factors:

• Expenses: #18/50
• Liquidity: #10/50
• Diversification: #27/50
• Risk: #28/50
• Size: #43/50
• Growth: #12/50
• Value: #34/50
• Quality: #3/50
• Momentum: #11/50
• Sentiment: #5

These are the rankings all-weather ETFs should have, and it’s what Fidelity promised. FMDE can succeed in various market environments, particularly those that favor growth, quality, and momentum. Since it’s also diversified, has a solid track record, and has a reasonable 0.23% expense ratio, I rate it a “buy.” Thank you for reading, and I look forward to your comments below.