~ by Snehasish Chaudhuri, MBA (Finance)
Principal U.S. Mega-Cap ETF (NASDAQ:USMC) is an exchange traded fund that invests in growth and value stocks of mega-cap companies, within the market capitalization range of the top 50th percentile of the S&P 500 Index. The fund seeks long-term growth of capital. USMC has an asset under management of $1.5 billion, and has a low expense ratio of 0.12 percent. The fund is actively managed and has a turnover ratio of 28.8 percent. It generates low yield, but has posted double-digit total returns over the past five years. This is despite having an extremely poor 2022. YTD returns have been in excess of 20 percent and USMC is currently trading almost at par with its net asset values.
USMC Has an Actively Managed Portfolio & a Weighted Market Cap of $790 Billion
Launched by Principal Financial Services, Inc., USMC is managed by Principal Global Investors, LLC. The fund was earlier named Principal U.S. Mega-Cap Multi-Factor Index ETF, and was renamed on September 30, 2020. On June 10, 2022, USMC ceased tracking the NASDAQ US Mega Cap Select Leaders Index and transitioned to an actively managed fund. Then onwards Principal U.S. Mega-Cap ETF is seeking to benchmark itself with the performance of S&P 500 Index and has been employing quantitative analysis to create its portfolio.
Stocks in the S&P 500 with the largest market capitalizations are first selected, and then higher weightage is assigned to the low-volatility stocks. Weighted average market capitalization of stocks included in USMC’s portfolio currently stands at $790 billion. Its portfolio is rebalanced at least once a year, but the fund adviser has the discretion to make adjustments. In constructing the model and managing the portfolio, inputs are collected from multiple sources which include internal research, industry reports, and third-party data.
USMC Generates Low Yields, But Double-Digit Total Returns on a Consistent Basis
Principal U.S. Mega-Cap ETF was formed on October 11, 2017 and has been paying quarterly dividends for the last 22 quarters on a continuous basis. Annual average yield since 2019 stood at 1.8 percent, which is comparatively low. This yield is insufficient to fulfill the needs of income-seeking investors. However, the fund generates strong and steady total returns. Year-to-date (YTD) total return has been 20.7 percent. Despite a poor 2022, USMC has been successful in posting an annual average total return of 10.8 percent. During both these periods, these returns went beyond the returns of S&P 500.
Due to Investing in Top 50th Percentile of S&P 500, USMC is a Tech Focused Fund
As the fund invests in the top 50th percentile of the S&P 500 Index, almost half of its assets are invested in stocks of companies that are heavily reliant on information and communication technology. 15 such stocks account for 51.5 percent of USMC’s entire holdings. Not surprisingly USMC has allocated almost 29 percent of its assets to the 7 major meg-cap technology stocks that sets the trend and direction of the broader market. Apple Inc. (AAPL), Microsoft Corporation (MSFT), Amazon.com, Inc. (AMZN), NVIDIA Corp (NVDA) Alphabet Inc. (GOOGL), Tesla Inc (TSLA), and Meta Platforms Inc (META) – all are among the top 20 holdings of Principal U.S. Mega-Cap ETF.
Adobe Inc (ADBE), Accenture PLC (ACN), Broadcom Inc (AVGO), Mastercard Inc (M), Visa Inc (V) Cisco Systems Inc (CSCO) Salesforce Inc (CRM) Texas Instruments Inc (TXN) are some more stocks that feature among the top 20 investments of Principal U.S. Mega-Cap ETF. Although technology stocks are cyclical in nature, mostly these stocks move in sync with the broader market. Driven by future potential of artificial intelligence (AI) and how innovative technologies might continue to generate new businesses and open up unexplored revenue streams, these technology-oriented stocks are expected to be in demand for a decade. However, due to high expectations these stocks can not overcome high volatility, which makes these stocks a little bit risky. In case of any adverse price performance, their huge market capitalization may drag down the entire fund. Investors must keep this factor into consideration.
Investment Thesis
Principal U.S. Mega-Cap ETF is an actively managed fund that invests in stocks with largest market capitalizations falling within the top 50 percentile of the S&P 500 index. Weighted average market capitalization of stocks included in USMC’s portfolio currently stands at $790 billion. USMC’s yield is insufficient to fulfill the needs of income-seeking investors. However, the fund has posted double-digit total returns over the long-run, despite a poor 2022. Its total returns have always surpassed the returns of S&P 500. As the fund invests in the top 50th percentile of the S&P 500 Index, more than half of its entire asset is invested in stocks of companies that are heavily reliant on ICT.
AI and innovative technologies might continue to generate new businesses and open up unexplored revenue streams. As a result, technology-oriented stocks are expected to be in demand for at least a decade. However, in case of adverse price performance, their huge market capitalization may drag down the fund to such a low that it might fail to generate any price growth. In absence of price growth, this low-yielding fund will become unattractive to its investors. I would prefer investors to remain adequately diversified across all asset classes and over various other industry segments, in case they are looking for long-term exposure in Principal U.S. Mega-Cap ETF. Thus, I won’t recommend further accumulation of this fund and shall assign a hold rating.
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