RFG: A Pure Play On Mid-Cap Growth (NYSEARCA:RFG)

One day, hopefully in my lifetime, the stock market won’t be led by just a few select mega-cap names. One day, hopefully in my lifetime, mid-caps and small-caps become the place to focus the most on. And one day, in your lifetime, you’ll take a look at this part of the marketplace for undervalued opportunities.

If today is that day, you may want to consider the Invesco S&P MidCap 400® Pure Growth ETF (NYSEARCA:RFG). This is an exchange-traded fund or ETF, that seeks to provide exposure to a selection of US midcap equity stocks that, collectively, fit within the growth style of investing.

RFG is an exchange-traded fund that tries to track the performance of the S&P MidCap 400® Pure Growth Index. That index is a subset of the larger S&P MidCap 400® Index and includes securities that exhibit strong growth characteristics based on a proprietary multifactor scoring system. In compiling the index, each stock in the S&P MidCap 400® is given two rankings, one value- and one growth-oriented. The rankings are based on various fundamental metrics, including book-value-to-price ratio, earnings-to-price ratio, sales-to-price ratio, three-year sales per share growth, the three-year ratio of earnings per share change to price per share, and momentum (12-month percentage change in price).

The growth score is then divided by the value score to see which stocks are most deeply valued, and each stock is ranked as “deep value,” “blend,” or “deep growth.” Only the “deep growth” stocks make their way into the index, whose weights are based on growth characteristics – the stronger the growth signals, the higher the allocation.

A Look At The Holdings

This is decently diversified given the strict criteria used in the index. The fund has 84 holdings, with no position making up more than 2.65% of the fund. As I’ve said in other writings, I’m a fan of funds like this, given how much concentration risk there is in large-cap market-cap weighted averages.

It’s worth noting that despite this being a mid-cap fund, it does have some small-cap exposure when we look at the overall market cap and style allocations. I don’t mind this as I like the small-cap space for a potential relative strength cycle ahead, but still, it’s something to keep in mind as it potentially makes the fund a bit more volatile.

Sector Composition and Weightings

Here’s where things get to be a bit tricky in my view. The largest sector allocation here is in Consumer Discretionary names, with a nearly 25% allocation. Industrials are second, followed by Energy and Tech. My concern on the discretionary side is simple: the unemployment rate is rising, consumers are beyond stretched, and stocks in this part of the marketplace would be very sensitive to recession.

If this doesn’t bother you, I still think it’s worth considering this when thinking about how much capital you might want to risk as a percentage of your portfolio in a portfolio like this.

Peer Comparison

There are plenty of mid-cap growth funds out there. One that may be worth comparing this against is the Vanguard Mid-Cap Growth Index Fund ETF Shares (VOT) which has a different screening process for how it determines growth stocks. When we look at the price ratio of two, we find that RFG has outperformed VOT.

Why? The sector composition is very different.

I’m not sure if we can come up with any firm conclusions on a price ratio basis here, as the screening for what is considered mid-cap growth is clearly different between the two funds. Still, RFG does appear to have an edge.

Pros and Cons

On the plus side, Invesco S&P MidCap 400® Pure Growth ETF provides focused exposure to midcap growth stocks that, over longer time frames, have a good chance of outperforming. The methodology does seem to be fairly “pure” in exposing investors to what are true growth plays within the mid-cap space.

On the other hand, investors should be aware of the greater volatility associated with growth stocks, which are typically valued on their future earnings potential, and increased liquidity risk relative to large-cap equities in the mid-cap segment, which could amplify price movements during periods of market stress.

Conclusion

Overall? The Invesco S&P MidCap 400® Pure Growth ETF looks strong. It provides exposure to the US equity market’s mid-cap growth segment, targeting companies that can take advantage of favorable industry fundamentals to deliver enhanced growth relative to the rest of the larger mid-cap segment. This ETF identifies its constituents through a rules-based methodology, with strong forward-looking quality traits and sustainable, accelerating earnings growth embedded in the stock selection process. So as mentioned, if this is the day in your life you start thinking about mid-cap investing, this is a fund to consider today.