SPMO: Low-Yielding S&P-Based Momentum ETF Better Than The Broader Market (NYSEARCA:SPMO)

~ by Snehasish Chaudhuri, MBA (Finance)

Invesco S&P 500 Momentum ETF (SPMO) is an exchange traded fund that invests in momentum stocks of companies operating across diversified sectors. Momentum means a tendency of investments exhibiting consistency in their relative performance. Historically, momentum funds have exhibited higher volatility relative to vanilla funds. It has an asset under management of $206 million, and an expense ratio of 0.13 percent. As the fund consists of the best 100 momentum stocks, turnover ratio is exceptionally high at 124 percent, as momentum changes very frequently. SPMO pays quarterly dividends, but with a yield mostly ranging between 1 to 2 percent. However, total returns have been impressive over the long run. SPMO’s price multiples are relatively lower, and the fund is currently trading at a premium of 0.14 percent from its NAV.

This Momentum Fund Offers Steady Yield and Generates Strong Total Return

Invesco S&P 500 Momentum ETF was launched on October 9, 2015 by Invesco Capital Management LLC. It seeks to track the performance of the S&P500 Momentum Index, by using full replication techniques. S&P500 Momentum Index measures the performance of 100 stocks with the highest momentum score. A momentum score is calculated on the basis of 12-month price growth (excluding the most recent month) and then is scaled by their volatility (of daily returns) with respect to the index. Momentum investing emphasizes investing in securities that performed better than other securities in the recent past. This index is redesigned and rebalanced semi-annually.

Invesco S&P 500 Momentum ETF has managed to generate strong total returns over the long run. Annual average total return between 2016 and 2021 stood in excess of 18.5 percent. This return was achieved despite a very low annual average yield, 1.12 percent. Although, income-seeking investors may feel disheartened, long-term growth seeking investors should be lured by such returns. However, it has suffered a lot over the past 20 months. Although the broader market performed poorly in 2022, it posted significant returns during this year. However, SPMO generated a year-to-date total return of only 2.87 percent, while the return of S&P 500 was 13.9 percent during the same period.

Momentum Stocks Might Exhibit High Volatility And Produce Significant Biases

SPMO invests in 100 stocks that have the highest momentum scores among the stocks listed in the S&P 500. Those 100 stocks are then weighted by their momentum score (after duly adjusting for volatility) and scaled by their market capitalization. Adjusting for volatility through this process tilts the fund toward stocks that exhibited smooth price increases. As a result of this the fund is expected to be tilted towards a few industry segments. This methodology may also produce significant bias relative to the broader market.

Invesco S&P 500 Momentum ETF invests 70 percent of its net assets in three of the most high-growth potential sectors – information & communication technology (ICT), industrial and healthcare. 25 out of ETJ’s top 30 investments are made in these three sectors. In the healthcare sector, major investments are made in companies like Eli Lilly & Company (LLY), Merck & Co., Inc. (MRK), Intuitive Surgical, Inc. (ISRG), Vertex Pharmaceuticals Incorporated (VRTX), Stryker Corporation, (SYK), Gilead Sciences, Inc. (GILD), Boston Scientific Corporation (BSX) and Regeneron Pharmaceuticals, Inc. (REGN). Mostly these stocks belong to medical equipment manufacturers or biotechnology firms.

Momentum Stocks Are Quite Different From the Most Demanded Giant-Caps

Major investments in ICT sectors included few semiconductor developers like NVIDIA Corporation (NVDA), Broadcom Inc. (AVGO), Applied Materials, Inc. (AMAT) and Lam Research Corporation (LRCX). Other major investments in this sector were Oracle Corporation (ORCL), Booking Holdings Inc. (BKNG), Meta Platforms, Inc. (META), Netflix, Inc. (NFLX) and Palo Alto Networks, Inc. (PANW). The list is quite different from the most demanded giant-cap technology stocks. It seems momentum stock needs to have some x-factors like being a semiconductor firm, cybersecurity providers, ERP developers, digital media, etc. Giant-cap system software companies and application software companies seem to be left out from the list of momentum stocks.

General Electric Company (GE), Caterpillar Inc. (CAT), The Boeing Company (BA), Linde plc (LIN), Eaton Corporation plc (ETN), Schlumberger Limited (SLB), Deere & Company (DE), Illinois Tool Works Inc. (ITW) are the stocks in the industrial sector the fund has bet on. These stocks mostly operate in niche industry segments and market leaders in those industry sub-segments. GE is the market leader in the energy value-chain, Boeing dominates the aerospace market. CAT is a leading player in the area of manufacturing of construction and mining equipment. LIN dominates in industrial gas production, ETN is an established name in electrical components manufacturing, SLB leads the technology space in the energy industry. DE is a big name in agricultural and farm machinery, while ITW leads in the industrial equipment segment. These companies also have an inclination towards new-age & modern technologies.

Investment Thesis

Invesco S&P 500 Momentum ETF invests in momentum stocks of diversified companies. Momentum investing implies investing in stocks that performed better than other securities in the recent past. Due to this, the fund is expected to be tilted towards a few industry segments that have performed better during the past one year. Not surprisingly, 70 percent of SPMO’s investments are made in three of the most sought-after sectors – industrial, technology & communication, and healthcare. Momentum stocks also produce significant bias relative to the broader market. Momentum funds also exhibit higher volatility, and accordingly such funds generally exhibit a higher turnover ratio.

In the healthcare sector, investments are made in medical equipment manufacturers or biotechnology firms. Most giant-cap tech firms fail to qualify as momentum stocks and top holdings in this sector were primarily in semiconductor firms, cybersecurity providers, ERP developers, digital & social media space, etc. Nowadays, these companies possess certain competitive advantages. Stocks of industrial companies operating and commanding some niche industrial sub-segments have also exhibited strong price momentums.

Despite very low yield, SPMO’s total returns have been impressive over the long run. Of late, the fund failed to generate adequate returns. However, in my opinion, this fund possesses the essential elements that will enable it to generate strong total returns over the long run. Poor price growth over the past 20 months also works in its favor. SPMO’s average price multiples are also relatively lower than its benchmark index and similar funds. However, the fund generates very low yield and is currently trading at a marginal premium. So, considering all these above-mentioned factors, I would assign a hold rating.