FMDE ETF: A Great All Weather ETF for Mid-Cap Investors (NYSEARCA:FMDE)

investment thesis

Fidelity Enhanced Mid Cap ETF (NYSEARCA:FMDE) reorganized from a mutual fund on November 17, 2023 and now offers ETF investors access to an actively managed strategy with a solid track record of outperforming its benchmark, the iShares Russell Mid-cap ETFs (IWR). In this article, I’ll compare FMDE’s fundamentals to IWR and three other passive index funds and explain why I think it’s the best choice for mid-cap investors. I hope you enjoy reading.

Overview of FMDE

FMDE, formerly known as the Fidelity Mid Cap Enhanced Index Fund, was 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 the most recent prospectus document states that Mr. Kaufmann will retire on or about March 31, 2024. In the absence of a revised prospectus, I assume it is still with the firm, but his retirement presents a continuity risk for the fund.

However, the other three portfolio managers are industry veterans. For example, this ad of 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 equity funds.” Mr. Naik previously worked at Geode Capital Management, the sub-advisor to many Fidelity funds, so I’m sure the ETF is in good hands. Furthermore, FMDE’s selection process seems largely automated. From the prospectus, the main investment strategy of the fund is:

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

Additionally, the aforementioned 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 used by funds such as the Invesco Russell 1000 Dynamic Multifactor ETF (OMFL). While the OMFL 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 the time” approach brings humility to the strategy. In other words, no analyst, computer-aided or otherwise, has all the answers, but improving statistics on critical factors such as value, growth and quality can also increase the fund’s chances of long-term success.

Finally, FMDE’s expense ratio of 0.23% is higher than its passive peers. For example, IWR’s expense ratio is 0.19%, while the iShares Core S&P Mid-Cap ETF (IJH) and the 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. So let’s look at it next.

FMDE analysis

Performance Summary

The following table highlights FMDE’s total revenue since inception compared to IWR, IJH and VO. Through August 2024, FMDE and its predecessor fund have earned 353.36%, about 21% and 19% better than IWR and VO. However, it lagged IJH by about 8%. In particular, IJH, which tracks the S&P MidCap 400 index, has some built-in profitability screens for new entrants, which is why it has outperformed over the long term.

Despite FMDE’s underperformance, IJH delivered stronger risk-adjusted returns over this period due to its lower standard deviation (18.22% vs. 19.13%). Furthermore, its “worst month” figure of -19.90%, which occurred in October 2008, was about 2% better than these three peers. While these differences are small, they still suggest that FMDE is part of the discussion about which mid-cap blend ETF is the best.

Over the past ten years, FMDE’s total return of 150.83% ranks 6/17 among mid-cap blends. Top performers like XMMO and XMHQ focus on a single factor and may only be suitable in certain circumstances, but when it comes to broad strategies, FMDE’s track record is strong.

FMDE fundamental analysis

The following table highlights selected fundamentals 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 is still quite low. In contrast, XMMO and XMHQ figures are 86.34% and 77.76% respectively. Therefore, you give up a lot of diversification benefits when you focus on just one factor, which adds to portfolio risk if those factors fall out of favor.

Here are three additional things to consider:

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

2. FMDE has an edge over these three peers in earnings growth and valuation metrics. For example, its constituents have grown earnings by 10.77% annually over the past three years, with analysts expecting an additional 11.28% growth for the next twelve months. These figures are 1-3% better than IWR, IJH and VO, while FMDE also sports an attractive forward P/E of 16.90x.

3. FMDE is a high-quality fund, highlighted by a profit score of 8.16/10, which we derived from individual Seeking Alpha Factor Grades. It also has excellent earnings momentum based on its EPS revision score of 6.84/10 and its earnings surprise of 9.52% last quarter. The table identifies FMDE Application Software stocks as the 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 a “A-” Seeking Alpha EPS Revision Grade, with 31/31 analysts raising earnings expectations over the past 90 days.

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Investment recommendation

FMDE is designed as an all-weather mid-cap blended ETF, and my analysis confirms that 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
• Moose: #11/50
• Sentiment: #5

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