MDYG ETF: Not Better Than Its Large-Cap Growth Peer Fund

ETF Overview

SPDR S&P 400 Mid Cap Growth ETF (NYSEARCA:MDYG) invests in a portfolio of U.S. mid-cap growth stocks. The fund has done quite well since 2022, but its performance still trailed its large-cap growth peer fund. This underperformance was primarily due to its low exposure to technology stocks. Hence, MDYG’s consensus long-term earnings growth rate is inferior than its large-cap growth peer. The fund may also experience a greater magnitude of pullback than its large-cap peer in a bear market. Therefore, investors may want to seek alternatives instead.

Fund Analysis

MDYG has walked out of the cyclical low reached in 2022 and set a new record this year

MDYG has performed quite well since the cyclical low reached in mid-2022. As can be seen from the chart below, since June 16, 2022, MDYG delivered a price return and total return of 44.6% and 48.1% respectively. This return was quite good over the span of nearly 2 years. The fund outperformed its small-cap growth peer, SPDR S&P 600 Small Cap Growth ETF (SLYG), which delivered a total return of only 31.9%. However, MDYG still underperformed its large-cap growth peer, SPDR Portfolio S&P 500 Growth ETF (SPYG), which delivered a better total return of 53.6%.

MDYG has underperformed its large-cap peer in the past decade

If we look at MDYG and its peers’ performance over the span of 10 years, we still see a similar trend. In the past 10 years, MDYG has delivered a total return of 164.4%. This return was slightly better than the 153.7% total return of SLYG, but underperformed SPYG by a wide margin. As can be seen from the chart below, MDYG’s total return of 164.4% was much inferior than SPYG’s 290.9%.

MDYG’s exposure to technology stocks is limited

We think one major reason why MDYG underperformed SPYG was due to the S&P 400 index’s low exposure to information technology. In fact, information technology sector only represents about 10.1% of the S&P 400 index. Since MDYG’s portfolio only selects growth stocks from the S&P 400 index, the lack of exposure of technology stocks means that MDYG’s exposure to technology stocks will also be limited. This is indeed the case. As can be seen from the table below, information technology sector still only represents 12.4% of MDYG’s total portfolio. In contrast, technology stocks represent 48.9% of SPYG’s total portfolio. That is nearly half of SPYG’s portfolio.

As we know, technology sector has been growing rapidly in the past few decades. Many technology ETFs can easily beat the broader market by a large margin. We will use a chart below to show why this low exposure to technology was a big drag on its performance in the past. We know from the table above that the 4 top sectors in MDYG’s portfolio are: industrials (29.3%), consumer discretionary (17.7%), information technology (12.4%), and health care (9.1%) sectors. Below is a chart that shows 4 ETFs that focuses on these 4 sectors. As can be seen from the chart, Technology Select Sector SPDR ETF (XLK) delivered a total return of 553.1% in the past 10 years. In contrast, the remaining three ETFs that focus on industrials, consumer discretionary and health care sectors only delivered returns between 179% and 202%. This explains why MDYG’s low exposure to technology stocks was the big reason why it underperformed its large-cap peer, SPYG.

Will MDYG’s underperformance continue in the upcoming year?

Below is a chart that shows the estimated annual EPS growth rate of different sectors in the S&P 500 index in 2024 and 2025. While the average EPS growth rates for different sectors are based on stocks in the S&P 500 index and not for stocks in the S&P 400 index, it does help us see the growth trends for different sectors. In other words, what is important are not the exact growth rates, but the growth strength across different sectors in 2024 and 2025. For example, information technology sector is expected to experience strong growth rates in both 2024 and 2025 and will beat most other sectors. It is likely that mid-cap technology stocks will experience outperformance against other sectors as well. On the other hand, consumer staples and utilities sectors have lower growth rates than many other sectors. This will likely also be the case for mid-cap utilities and consumer staples sectors. MDYG’s low exposure on technology stocks means that it will not enjoy the full benefit of the technology boom in 2024 and 2025.

One good news is that industrials sector is expected to grow rapidly in 2025. In fact, the sector is expected to capture 15.1% growth rate in 2025. This is going to be much higher than 2024’s 2.3%. We know that this sector represents about 29.3% of MDYG’s portfolio. Therefore, we do think MDYG will likely deliver better returns in the upcoming year than the past year. However, industrials sector’s growth rate in 2025 still trails information technology’s growth rate of 20.5%. Hence, we think SPYG’s heavy exposure on tech stocks will likely help it to continue to outperform MDYG in terms of earnings growth.

This is indeed the case if we look at the consensus estimates for stocks in MDYG and SPYG’s portfolio. As the table below shows, the long-term average earnings growth rate for stocks in MDYG’s portfolio is expected to be about 10.9%. This is over 4 percentage points lower than the 15.4% average growth rate of stocks in SPYG’s portfolio.

Click to enlarge

Source: Morningstar

MDYG’s downside risk cannot be ignored

Besides MDYG’s inferior long-term earnings growth rate than its large-cap growth peer, the fund may also underperform in a bear market. As can be seen from the chart below, MDYG experienced a much higher magnitude of decline than SPYG in most of the market corrections in the past 10 years, except during the decline in 2022. Just like a large boat that can weather the storm better than small boat, large-cap stocks typically have proven business models and stronger balance sheets. Therefore, they tend to perform better than its mid-cap and small-cap peers.

Investor Takeaway

MDYG has a portfolio of mid-cap growth stocks. However, the fund will likely underperform its large-cap growth peer due to its low exposure to technology stocks. Hence, we think investors may want to seek other growth ETFs instead.

Additional Disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.