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Continuing my series of research notes discussing multi-factor equity ETFs, today I want to dissect the Franklin U.S. MidCap Multi-Factor Index ETF (Bat: FLQM), a smart beta tool that blends quality, value, momentum and low volatility factors into a portfolio Consists of the most valuable Russell MidCap Index constituents.
Despite a combination of sound factors under the hood and fairly interesting past performance, I’m not a fan of this car. The problem here is that I see some nuances about the size factor, growth credentials, and past performance that don’t support the bullish view. All of this will be discussed in today’s article.
FLQM’s strategy
According to its websiteFLQM “pursues long-term downside risk capture and strong risk-adjusted returns,” with a fundamental element of its strategy being the semi-annual restructuring of LibertyQ US Mid Capped stock index. The idea is to select the most valuable components of the Russell MidCap Index using a combination of factors: “50% Quality, 30% Value, 10% Momentum and 10% Low Volatility.” Some details on the exact metrics used For information, see page 14 of this document. prospectus. Furthermore:
- Quality is assessed using return on equity, gross margin on assets and gross margin sustainability.
- Value characteristics are measured through forward yield, EBITDA/enterprise value, price-to-book ratio and dividend yield.
- Momentum is based on 6-month and 12-month risk-adjusted price momentum.
- Use beta to assess low volatility.
In addition, the weight of a single company is capped at 1%. However, assuming market values fluctuate between restructurings, it’s not surprising that 15 of the 204 stocks had a weighting of more than 1% as of April 1.
FLQM is essentially a large-cap ETF
I think FLQM is hardly a mid-cap ETF. The facts clearly illustrate this point.
First, as of April 1, FLQM’s portfolio of 204 stocks and REITs had a weighted average market capitalization of $24.48 billion, which is almost 1.5 times higher than the top mid-cap reference point, according to my calculations. Its median portfolio is $12.93 billion. Digging deeper, we find that 85% of holdings have a market capitalization of over $10 billion, with the largest holding being Phillips 66 (PSX) with a valuation of $69.88 billion; PSX has a portfolio weight of 1.08%.
This is explainable, since the universe of choice is to blame. By my calculations, the iShares Russell Mid-Cap ETF (IWR), which tracks an index representing FLQM’s chosen universe, had a market capitalization of $27.8 billion as of April 1.
To get a little more context, I decided to check out the overlap between the ETF and the SPDR S&P MIDCAP 400 ETF Trust (MDY).MDY has a market capitalization of $9.15 billion in WA, according to its data website. My calculations show that the overlap is not significant, with MDY holding only 26.4% of FLQM’s weight.
Meanwhile, FLQM has nearly 69% of its net assets allocated to S&P 500 stocks, as a comparison of its portfolio to the iShares Core S&P 500 ETF (IVV) shows.
Therefore, as I often mention in my articles, mid-cap investors should be prepared to compromise, or choose a different ETF. One example worth considering is the Invesco S&P MidCap Quality ETF (XMHQ), which I profiled in October 2023. At the time, its weighted average market capitalization was just $8.2 billion.
FLQM has quality-focused portfolio, suboptimal valuation and slow growth
With quality factors being the cornerstone of its strategy, FLQM does deliver solid profitability and capital efficiency. Let me illustrate this with the key facts below.
First, according to my calculations, FLQM has a weighted average return on assets of 11%. This level is certainly healthy. Meanwhile, IWR’s ROA is only 5.9%. The obvious reason is that FLQM increases the visibility of high ROA names. Here are some of the most noteworthy examples I’ve found.
| symbol | Weight, % (as of April 1) | IWR weight, % (as of April 1) | long |
| Trane Technologies (TT) | 1.12 | 0.59 | 10.4% |
| Diamondback Energy (FANG) | 1.1 | 0.31 | 10.8% |
| Fastener Company (FAST) | 1.09 | 0.38 | 25.9% |
| WW Granger(GWW) | 1.09 | 0.39 | 22.4% |
| Builder FirstSource (BLDR) | 1.07 | 0.22 | 14.7% |
Created by the author using data from Seeking Alpha and ETFs.Financial data as of April 2
Second, while only 81.7% of IWR’s net assets are allocated to companies with a B-Quant Profitability Rating or better, FLQM has nearly 93% of the allocation. Notably, by my calculations, the FLQM and IWR portfolios overlap by only 29%.
Speaking of ROE, providing a precise weighted average result is complicated because both portfolios are exposed to companies with four-digit and triple-digit ROEs that suffer from excessive borrowing on their balance sheets. And deviation occurs. Therefore, I decided to adjust both metrics to eliminate companies with excessively high or negative returns on equity. The result is as follows:
| ETF | Adjusted return on equity |
| FLQM | 24.8% |
| internal water reaction | 16.9% |
The author calculated this using data from Seeking Alpha and ETFs
The Franklin ETF once again significantly outperformed IWR.
FLQM also fares a little better than its less selective peers when it comes to valuation, as it has a larger proportion of holdings with a B-Quant valuation grade or better and stronger weighted average earnings and dividend yields.
| Metric | FLQM | internal water reaction |
| Quantitative Valuation B- or better | 18.48% | 15.78% |
| Ernst & Young | 5.41% | 3.71% |
| Dee | 1.69% | 1.44% |
| revenue forwarding | 3.92% | 6.80% |
| EPS forward | 5.15% | 9.61% |
The author calculated this using data from Seeking Alpha and ETFs
However, because FLQM does not target growth factors, the characteristics of its portfolio are significantly softer than those of IWR.
Still, in terms of momentum, the Franklin ETF remains confidently ahead.
| Metric | FLQM | internal water reaction |
| Quantitative Momentum B- or better | 75.66% | 69.71% |
The author calculated this using data from Seeking Alpha and ETFs
FLQM also slightly outperforms IWR in terms of low volatility, with a 24-month weighted average beta of 0.998 compared to IWR’s 1.12, according to my analysis.
FLQM Performance: Nuances That Can’t Be Ignored
As I already mentioned above, ETFs “pursue long-term downside capture and strong risk-adjusted returns.” It has clearly been successful in this regard, with annualized returns significantly higher than IWR and a much smaller downside capture rate.
| Folder | FLQM | internal water reaction |
| Initial balance | $10,000 | $10,000 |
| final balance | $22,660 USD | $19,490 |
| CAGR | 12.88% | 10.39% |
| standard deviation | 18.43% | 19.65% |
| best year | 28.76% | 30.23% |
| worst year | -12.95% | -17.48% |
| maximum.retracement | -25.06% | -27.13% |
| Sharpe ratio | 0.65 | 0.5 |
| Sortino Ratio | 0.99 | 0.75 |
| market relevance | 0.96 | 0.97 |
| Downstream capture rate | 98.23% | 106.23% |
| Upstream capture rate | 97.26% | 95.14% |
Data from portfolio visualization tools.Period July 2017 to March 2024; shortened due to unavailability of data for May and June 2017
Since launch, it is nearly 34% faster than IWR (as of April 3).
Seeking Alpha
However, to ensure proper context, we should evaluate how this ETF compares to pure mid-cap funds like the Schwab US MidCap ETF (SCHM), MDY, and XMHQ, as well as the market, which I believe generally uses the IVV proxy.
| Folder | FLQM | intravenous injection | SM | XSHQ | MDY |
| Initial balance | $10,000 | $10,000 | $10,000 | $10,000 | $10,000 |
| final balance | $22,660 USD | $24,340 | $18,711 | $18,037 | $19,026 |
| CAGR | 12.88% | 14.09% | 9.73% | 9.13% | 10.00% |
| standard deviation | 18.43% | 17.12% | 20.67% | 20.42% | 20.74% |
| best year | 28.76% | 31.25% | 27.47% | 24.01% | 25.78% |
| worst year | -12.95% | -18.16% | -17.06% | -15.02% | -13.28% |
| maximum.retracement | -25.06% | -23.93% | -29.57% | -30.38% | -29.63% |
| Sharpe ratio | 0.65 | 0.74 | 0.46 | 0.43 | 0.47 |
| Sortino Ratio | 0.99 | 1.14 | 0.67 | 0.69 | 0.69 |
| Upstream capture rate | 97.26% | 100.45% | 95.59% | 83.3% | 95.2% |
| Downstream capture rate | 98.23% | 97.24% | 109.7% | 95.96% | 108.01% |
Data from portfolio visualization tools.The period is from July 2017 to March 2024
So while FLQM beat the pure mid-cap ETF, it underperformed IVV by 1.21% and also provided a higher downside capture rate.
Important points for investors
At first glance, FLQM offers a well-calibrated proposition for passive multi-factor investing in the mid-cap space. It offers the advantages of quality, value, momentum and low volatility and represents a leaner, more efficient version of IWR with solid returns. However, I found some questionable nuances, including the size factor (since this is a large-cap-heavy portfolio), the slow-growth characteristics that aren’t ideal for the current environment, and the ETF’s inability to beat the market in the past. As one. In this regard, I initiate a conservative Hold rating.
