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A Better ETF Idea For Mid-Caps

ETF Professor

Mid-cap equities have been scorching hot, dating back to last year. The widely followed S&P MidCap 400 Index jumped 20.5 percent in 2016 and is higher by nearly 3 percent to start this year.

Mid-caps are often prized by investors for impressive growth prospects, but the search for growth does not mean investors should sacrifice profitability and earnings quality. The WisdomTree MidCap Earnings Fund (ETF) (NYSE: EZM) weights its holdings by earnings, demanding profitability of its more than 570 holdings, a requirement not found with all mid-cap exchange-traded funds.

An issue that fundamentally-weighted ETFs, such as EZM, encounter is the widely held belief that holding a simple, traditional index over the long-term is the best way for conservative investors to generate solid returns. EZM proves different. At the very least, EZM proves different can be rewarding.

EZM's Index

EZM follows the fundamentally-weighted WisdomTree MidCap Earnings Index. That index has an emphasis on core earnings, which “is a standardized calculation of earnings developed by Standard & Poors designed to include expenses, incomes and activities that reflect the actual profitability of an enterprises ongoing operations,” according to WisdomTree.

While EZM can be used as a complement or alternative to traditional mid-cap strategies, the ETF also fits the bill for investors looking for cyclical exposure at the sector level. For example, industrial and consumer discretionary names combine for 40 percent of EZM's lineup. The ETF's cyclical exposure does not end there as financial services and technology stocks combine for almost 29 percent of EZM's roster.

EZM's underlying index accesses “the value factor through their earnings-weighted methodology and annual rebalancing process. Each December, the indexes rebalance to include only profitable companies and then weight those companies based on the profits they generated in the prior year. This selection and weighting process typically lowers the aggregate price-to-earnings (P/E) ratio, a measure of value, relative to comparable market cap-weighted indexes,” said WisdomTree in a recent note.

How EZM is rebalanced is another advantage the ETF possesses over traditional cap-weighted mid-cap ETFs.

Strategy And Methodology

“In each and every case, at the annual rebalance going back to 2007, WisdomTree was able to lower the P/E ratio of each Index, while raising aggregate return on equity and return on assets compared to where they were before the rebalance,” said WisdomTree.

EZM has returned 33.2 percent over the past three years and has outperformed 99 percent of competing funds over the past decade.

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