ETF Trends CEO Tom Lydon discussed the Alger Mid Cap 40 ETF (FRTY) on this week’s “ETF of the Week” podcast with Chuck Jaffe on the MoneyLife Show.
FRTY primarily invests in a focused portfolio of approximately 40 holdings of mid-cap companies identified through Alger’s fundamental research as demonstrating promising growth potential.
The ETF is essentially a mid-capitalization fund strategy targeting today’s high-conviction stock picks. Looking at the historical outperformance of the mid-cap category, it has generated an annualized total return of 12.3% from 1990 through 2020, compared to the 11.0% for small caps and 10.7% for large caps over the same period.
Despite higher returns, mid-cap risk has historically come in between large- and small-caps. From 1990 through 2020, mid-caps showed a standard deviation of 16.3, compared to 14.6 for large caps and 19.2 for small caps. Over the long run, mid-caps have provided superior risk-adjusted returns given their historically high returns. From 1990 through 2020, mid-caps showed a 0.60 Sharpe Ratio, compared to 0.56 for large caps and 0.44 for small caps.
Recent underperformance has compressed mid-cap valuations as compared to history. Investors should consider the cheap valuations that mid-caps offer. Earnings estimates for mid-capitalization stocks are projected to grow much faster than for large caps.
Why Active Approach To Midcaps?
Market participants are not looking at mid-caps as closely as other market segments. Mid-cap stocks have less sell-side research coverage, with an average 10.7 number of analysts per mid-cap stock, compared to 20.6 analysts per large-cap stock. It is easier to have differentiated views on sales, earnings, cash flows, and ultimately value, given far fewer research analysts per mid-cap stock.
Alger’s approach to high conviction mid-cap investing seeks to generate alpha by making investment decisions based on fundamental, bottom-up research and conviction. They invest in companies with defensible competitive positions and high financial quality (e.g., solid balance sheets and strong cash flow generation), which typically provide better downside protection. There’s a focus on companies with solid operating histories that have the potential to double their revenue stream in five years. And finally, investment theses are realized over the years, not quarters, which can yield lower levels of portfolio turnover and trading costs.
The macro view is supportive of the overall equities market. Recent monetary stimulus in the U.S. has been unprecedented. An explosion in the money supply is still working its way into the real economy. Plus, the stimulus has driven very high savings levels, a portion of which will ultimately be spent and may drive very strong consumer spending.
As far as Alger’s current investment philosophy, the firm believes companies undergoing Positive Dynamic Change offer the best investment opportunities for our clients. This means having a competitive edge in identifying these companies and capitalizing on the change before the market recognizes it.
It’s important to embrace change found in “traditional” growth companies and in companies experiencing a “growth renaissance.” These “traditional” growth companies have growing revenues, growing unit volume, increasing market share, and an expanding business.