FELG: A Leaner Alternative To SCHG, Outperforming For Now

Continuing my series of articles on growth-focused exchange-traded funds, today I would like to review the Fidelity Enhanced Large Cap Growth ETF (NYSEARCA:FELG). Although it was incepted in 2007, most of FELG’s track record is irrelevant since it underwent a change in November 2023 as it was converted from a mutual fund to an ETF. FELG has had a rather ebullient start to its ETF history, as it has been benefiting from investors cranking up bets on longer-duration equities. However, it has not only appreciated impressively but also confidently bested the market and a few prominent names in the growth ETF arena, like the Schwab U.S. Large-Cap Growth ETF (SCHG) and the Invesco QQQ Trust ETF (QQQ). It has also beaten the iShares Russell 1000 Growth ETF (IWF), which tracks the index that essentially serves as a selection universe for FELG.

Assuming such a confident start, FELG certainly deserves a thorough review. To ensure an appropriate context, I decided to juxtapose its factor mix with that of SCHG, a fund that I called “one of the best choices for growth investors” in March. Can FELG beat the passively managed Schwab ETF on the factor front? Let us dig in.

What is at the crux of FELG’s strategy?

As we know from the Fidelity website, FELG seeks capital appreciation and is managed actively. How is it supposed to deliver robust total returns? The idea is to select a fraction of the Russell 1000 Growth Index with a high-return potential “using computer-aided, quantitative analysis of historical valuation, growth, profitability, and other factors.” This is a clearly interesting approach, assuming oftentimes growth strategies start with simpler selection universes like the largest 500 U.S. companies, the S&P 500, the Russell 1000, or a similar market-cap-weighted basket offering exposure to a certain market echelon, with growth and value stocks blended. In the case of FELG, the group it selects from already has an embedded growth factor ingredient. Importantly, the ETF may venture into foreign stocks, with examples from the current version of the portfolio being Spotify Technology S.A. (SPOT) and Nu Holdings (NU).

Does FELG have a factor edge over SCHG?

Despite having notable differences in composition, with FELG being much leaner (104 vs. 245 stocks in the SCHG portfolio), the ETFs have a lot in common, so it is questionable whether the Fidelity fund has an edge or not. In many ways, they are mostly on par, as 76.2% of FELG’s portfolio are stocks that are also present in the Schwab ETF. However, SCHG is offering a slightly stronger growth story, while FELG has larger exposure to highly efficient companies (as measured by ROE and ROA).

Both funds have sizable allocations to the trillion-dollar league, which has indeed contributed most to their solid gains this year. For SCHG, it is over 52%. For FELG, it is slightly below 50%. In this regard, it does not come as a surprise that both have similar weighted-average market capitalizations, $1.446 trillion for FELG and $1.49 trillion for SCHG, as per my calculations.

When it comes to sectors, differences are more noticeable.

For example, while both are overweight in IT sector stocks, FELG is a bit lighter in tech, with a 3.4% lower allocation. It is also less optimistic about health care, while more confident about the potential of the industrial and consumer discretionary sectors. From the latter, it is worth mentioning Home Depot (HD), which SCHG has ignored but FELG has not, allocating 1.7% of the net assets to it. I should say that I find it a bit counterintuitive how a stock with a 15 bps forward revenue growth rate and negative forward EBITDA and EPS growth rates has qualified for this portfolio.

Growth

At least in the current version, FELG does not have an edge over its more diversified peer. For example, it is offering an around 16.8% weighted-average forward revenue growth rate, while SCHG is sporting that rate at 18%, as per my calculations. There are a few reasons for that, chief among them being FELG’s smaller exposure to NVIDIA (NVDA), 10.8% vs. 11.4%. Also, it has about 3.7% allocated to companies that are forecast to deliver lower sales going forward, while in SCHG their weight is just 2.9%. When it comes to earnings, the Schwab ETF is again ahead, with a 27.1% WA forward EPS growth rate vs. FELG’s 26.1%. Overall, I believe the best indication here is that names that have earned a B- Quant Growth rating or higher have 73.5% weight in SCHG but only 63.8% in FELG.

Quality

Investors seeking a balanced growth & quality mix will likely be more than satisfied with both SCHG and FELG. However, the latter offers a stronger capital efficiency story, with both Return on Assets and adjusted Return on Equity higher than those of SCHG. Upon deeper inspection, I have found out that the difference is driven by the fact that FELG made better choices in the IT and energy sectors.

Click to enlarge

Calculated by the author using data from Seeking Alpha and the ETFs

However, it has a marginally smaller WA net margin of 25.2% vs. SCHG’s 25.6%. Besides, the latter has a 97.5% allocation to companies with a B- Quant Profitability rating or higher, which is 1% larger than FELG’s.

Value

In terms of value, FELG has a slight advantage over SCHG, as evidenced by its adjusted earnings yield (with negative figures removed) of 3.07%, while the SCHG has 2.76%. The P/S ratio is at 11.1x vs. SCHG’s 12x, in part again because of FELG’s smaller exposure to NVDA. Additionally, while SCHG holds almost exclusively grossly overvalued stocks from a Quant perspective (a 95.5% allocation to companies with a D+ Valuation rating or worse), FELG is a bit lighter in such names, with an 89.5% allocation.

Low volatility and momentum

Betting on longer-duration equities to continue climbing higher means being prepared for compromises not only on valuation but also on volatility. Growth exposure and high beta are interconnected, and both growth ETFs illustrate that. SCHG and FELG have their weighted-average 24-month beta coefficients at 1.26x and 1.24x, respectively, so they are clearly more volatile than the market. At the same time, they are substantially overweight in momentum names, though the Schwab ETF is once again slightly more competitive.

Click to enlarge

Calculated by the author using data from Seeking Alpha and the ETFs

Investor takeaway

In sum, FELG is a solid, actively managed vehicle that looks like a healthy choice to navigate the bull market driven by the AI narrative and dovish sentiment. It has quality, volatility, and growth characteristics that I would expect from a fund with a similar mandate. It did make an impression with its racy start, yet the issue here is its too short trading history after the conversion, so we can only hypothesize how it would fare in a down market like the one in March 2020 or 2022.

At the end of the day, what is the verdict? I believe FELG might be a nice alternative to SCHG or even QQQ. But the key problem is its expense ratio of 18 bps, while SCHG has just 4 bps. Besides, it has a greater depth of exposure and a much longer track record (incepted in December 2009). Next, SCHG has much more impressive liquidity.

So, I believe FELG is clearly worth shortlisting, but I am not convinced enough to initiate coverage with a Buy rating.