Fidelity MSCI Information Technology Index ETF – Go Gradual (NYSEARCA:FTEC)

Introduction and important capabilities

The Fidelity MSCI Information and facts Technology Index ETF (NYSEARCA:FTEC) provides buyers an opportunity to dabble with the broad US IT sector in the most successful way probable the ETF has an MER of .08%, which is incidentally the lowest in this US tech-targeted house. FTEC tracks the MSCI United states IMI Data Technological know-how Index. When you search at a bonafide expansion sector this kind of as tech, dividend returns usually are not pretty its raison d’être (as you want the excess cash to be plugged again into growing the small business), but you would be interested to know that, for a minimal dividend-having to pay sector, FTEC does have a first rate dividend keep track of record relative to other friends in this house. Around the final 4 several years, the dividend produce on offer you has been the highest in this area (and irrespective of the ETF staying up by just about 50% this calendar year, at this time, you can select up a generate of virtually 1%). Apart from getting grown dividends on a yearly basis for the past 6 many years (5-calendar year CAGR of c.17%) and even in 2020 when a great deal of ETFs have slice their quarterly payouts, FTEC has improved its payouts for the to start with 3 quarters – Q1: 56% YoY, Q2: +2% YoY, Q3: 1% YoY.

Supply: Trying to get Alpha

Superb historic threat-return stats

Supply: Yahoo Finance

More than the last 5 years, FTEC has been a superb resource of wealth technology for tech-hungry traders, outperforming the tech-flavored Nasdaq and the S&P500 very handsomely. That stated, it can be also important to glance at some of the hazard-adjusted return metrics to get a perception of how properly the ETF has been, at juggling its hazard, and delivering a return commensurate with this danger.

Source: Yahoo Finance

As you can see from the desk over, FTEC has created a superior alpha of 3x its class regular above the last 5 decades, and virtually two times that of its peers, more than the final 3 yrs. The signify once-a-year return too is nicely ahead of the average. On the lookout at the danger, we can see that volatility is on the higher side, with regular deviation (a evaluate of complete threat) coming in c.5% far more than the category typical. The ETF has a slight substantial-beta tilt, with beta around 1x, but in line with friends. The 3-yr R-square of pretty much 80 versus 63 for the category normal suggests that FTEC does a improved work at mirroring the movements of its benchmark than its friends (in other text, about 80% of the movement of FTEC can be discussed by movements in the MSCI United states of america IMI Data Know-how Index).

Extra hazard-altered returns are exemplified by a great Treynor ratio (that considers the beta or systematic chance), but presented FTEC’s normal deficiency of diversification, I would connect extra importance to full hazard (standard deviation) instead than just systematic threat (beta). So, the metric you require to aim on listed here is the Sharpe ratio, which actions surplus returns, for every device of complete possibility. Right here, far too, FTEC provides exceptional quantities perfectly forward of the class average, which fails to deliver excessive returns on par with the stage of danger taken (<1).

Holdings analysis – Not well-diversified and top-heavy

My gripe with this ETF is that it is not well-diversified despite offering investors a fairly large pool of over 330 stocks. FTEC’s holdings are dominated by the two most valuable companies in the world – Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) that jointly account for almost 40% of the total portfolio. The next 8 largest stocks account for a further 21% of the total holdings, which means, out of FTEC’s 331 stocks, the lowest 321 stocks by weight are, in effect, only contributing about 39% to the total holdings. Making up the numbers, did somebody say?

Look, I get it – most of the top-10 holdings are competent tech enterprises with a great track record of execution and the sustained ability to dominate their respective markets. For instance, just take the top two – whilst most companies have struggled in 2020, AAPL has come away relatively unscathed and is now on the cusp of entering Q1-21 which has traditionally been its strongest quarter for iPhone shipments. The remote work culture and increased digitization across the world have only reemphasized MSFT’s core expertise in data centers and cloud computing. The company’s shimmering gaming franchise is another feather in its cap. I acknowledge that these are high-quality businesses that warrant high-quality valuation multiples that justify their superior growth potential, but nonetheless, when you’re in the business of making money, it’s also important to demarcate the fine lines between what constitutes a great business and what constitutes a great investment. Regardless of their respective business prospects, at these valuation levels, I just find it difficult to accept that some of these companies that constitute the top-10 make for a compelling investment proposition. Also, consider that these large tech-names have very limited room to err as expectations are sky high for instance, do note that, in July, despite beating revenue and EPS consensus for Q4, MFST sold off by more than 5%.

Since the top-10 make up for over 60% of FTEC’s total holdings, I’ve focused on the relative valuations of only these 10. As you can see from the table below, based on future earnings estimates, all the stocks except Intel (NASDAQ:INTC) and Cisco (NASDAQ:CSCO) (and perhaps Adobe (NASDAQ:ADBE)) are trading at a significant price premium to their historical averages. On a weighted average basis, the forward P/E multiple of the top-10 of FTEC currently trades at a 57% premium to its historical average.

With growth stocks, you also want to corroborate if these stocks are justifying their earnings potential, so I also looked at the PEG (Price/Earnings-to-Growth) multiple based on forward earnings estimates, and even here, the current weighted-average multiple of the top10 represents a 47% premium over its historical average (which is above 1.5x for all stocks and indicative of their sustained historical growth capacity), with CSCO the only stock in the top-10, trading at a discount.

Source: Prepared by the writer using data from Seeking Alpha and YCharts

Price action – Wait for a pullback for better risk-reward

FTEC is currently witnessing strong momentum, with the ETF trading well above its key moving averages of 50, 100, and 200 on the daily chart, but I feel some caution may be warranted if you consider things from a larger time frame. If you look at the price action on the monthly chart, you can see that, from June 2016 to June 2020, FTEC was trending upwards via an ascending broadening wedge pattern. During most of this period, it respected the two boundary lines, forming healthy pullbacks when it had reached the upper boundaries, and then bouncing up from the lower boundaries. However, in July 2020, the ETF broke past the upper boundary of the wedge, making a steep parabolic move (which had begun since April), and only paused when it breached the psychologically crucial resistance of c.$100. Regardless of tech’s prospects, the steepness of the most recent up-move makes me rather nervy, and I feel potential investors would be better served if they wait for a third pullback and pursue an entry at lower levels of $75-80 (highlighted in blue), as this would represent a healthy pullback of 50% of the up move from April. This zone had also previously served as a crucial pivot point in Jan. and Feb. 2020 (the ETF fell away from here). Of course, I acknowledge that, if growth and tech stocks continue to bask in the limelight, a pullback to these $75-80 levels may never come, and alternatively, one may also see FTEC chop around sideways, within the narrow range of the upper wedge boundary of $90 and the resistance of $100 (area highlighted in yellow), before making an attempt to break past $100. Yet still, I would be hesitant to add positions at these elevated levels, particularly considering the steepness of the previous move and would rather stay on the sidelines.

Source: TradingView

Closing thoughts

To sum up, FTEC has an excellent track record of managing risk and delivering excess returns it also offers you exposure to some admirable tech names in a very efficient manner. That said, getting into a skewed, top-heavy, and over-valued tech ETF at this point of the economic cycle makes me rather queasy. The ETF has also recently had a very steep move and is now very close to a psychological resistance point. Investors would be advised to wait for a pullback to the $75-80 levels, before considering an entry.

Source: BofA Global Fund Manager Survey

In this business, it’s also important to follow where the smart money is going, and I think tech maybe susceptible here, as large swathes of the institutional investment community are poised to rotate away from growth and tech names into other pockets in the market as you can see from the charts above, a fund manager survey by BofA last month showed that tech was perceived to be the most over-crowded trade and rotating out of tech was one of the most popular themes, only behind rotation out of the Eurozone. Data from Bloomberg Intelligence also shows that, over the last two months, investors have pulled out $3.7 billion from growth funds, of which tech is a large part of. All things considered, I am neutral on FTEC.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.