FMCX: First Manhattan’s Debut Active ETF Is Too Expensive (NYSEARCA:FMCX)

Investment Thesis

The FMC Excelsior Focus Equity ETF (NYSEARCA:FMCX) only launched on April 22, 2022, but this large-cap blend fund is already trailing behind low-cost benchmarks like the SPDR Dow Jones Industrial Average ETF (DIA) and the SPDR S&P 500 ETF (SPY), undoubtedly leaving shareholders wondering what justifies its 0.70% expense ratio. This article aims to shed some light on FMCX’s fundamentals and reveals something surprising: a high valuation for a fund run by a value-oriented manager. In fairness, the selections are high quality with solid growth potential, but that’s common in the large-cap space, so I don’t view it as anything special. Therefore, I’ve assigned a “hold” rating to FMCX, and I look forward to taking you through its strategy, performance, and fundamentals in more detail below.

FMCX Overview

Strategy Discussion

According to its website, FMCX offers investors exposure to the highest-conviction ideas of First Manhattan’s research team. The firm, acting as FMCX’s investment adviser, offers the following reasons to invest:

• Research-intensive, bottom-up fundamental stock selection in high-quality businesses honed over six decades.
• Long-term investment horizon, with a target of 25-30 U.S. equities.
• A business owner’s mindset and engagement with portfolio companies.

First Manhattan’s research process involves a team of industry experts evaluating companies regarding the “growth potential and soundness of each business.” The process includes qualitative analysis, quantitative analysis, evaluation of financial reports, and meetings with management teams, customers, suppliers, and competitors. As a result, research analysts gain a unique perspective of a company’s strengths and weaknesses, with the team attempting to uncover value through the following means:

• fundamental operating model and financial characteristics
• understanding industry dynamics and a company’s competitive advantages
• assessing management quality and growth potential
• focusing on the generation and efficient reinvestment of cash

FMCX’s portfolio manager is Himayani Puri, a partner and Head of Research for First Manhattan. Its fact sheet notes over 27 years of experience as a value-oriented investor, and the majority of her time with First Manhattan involved building, managing, and leading the firm’s research efforts. To my knowledge, FMCX is the first fund where Ms. Puri has been listed as portfolio manager.

Lastly, FMCX uses the Precidian ActiveShares structure, allowing the firm to deliver an actively managed strategy in an ETF vehicle without disclosing its holdings in real time to the public. FMCX’s holdings are delayed by at least 60 days, with the latest holdings report as of May 31, 2024. I will rely on these holdings for my fundamental analysis, but I caution that they are not current. Portfolio turnover was 54% for the most recent fiscal year.

Fund Basics

FMCX has a 0.70% expense ratio and $97 million in assets as of August 27, 2024. For a boutique firm with over two years of history, it’s pretty solid. However, it’s a drop in the bucket compared to the $31 billion in assets managed by the firm. Personalized service through separately managed accounts is First Manhattan’s specialty, so I think the company is merely testing the waters of the ETF space with FMCX.

As a 30-stock fund, DIA is a close peer from a concentration perspective. I will also compare FMCX with SPY, as the S&P 500 Index is listed as its benchmark. There’s a good chance many readers own one of these ETFs, and for a 0.70% expense ratio, First Manhattan has a challenging job convincing the public that its approach is superior.

FMCX Analysis

Performance

Since May 2022, FMCX has delivered an 11.12% annualized return compared to 12.23% and 15.83% for DIA and SPY, respectively. The difference with SPY is not too surprising, given how difficult it was for anyone to predict the incredible success of the Magnificent Seven last year. However, FMCX also lagged behind DIA by more than its expense ratio difference (0.54%), which indicates its approach was inferior. The table below also reveals worse risk-adjusted returns, as measured by the Sharpe and Sortino Ratios.

From May to December 2022, FMCX declined by 6.85%, so unfortunately, it got off to a difficult start against DIA, which managed a 1.98% gain. Fortunes reversed the following year, and the two are running neck and neck in 2024. FMCX’s track record is limited, but these results suggest it’s more growth-oriented. It’s surprising to me, given how the portfolio manager’s bio mentions she is a value-oriented investor.

FMCX Fundamentals

The following table highlights selected fundamental metrics for FMCX’s top 25 holdings, totaling 94.92% of the portfolio. KKR & Co. (KKR), a global investment firm recently added to the S&P 500 Index, is the top holding at 8.15% and illustrates how First Manhattan’s long-term approach can work. The stock was deemed undervalued 5+ years ago when it was trading in the 40s and 50s and now trades at over $120 per share.

Here are four additional observations to consider:

1. FMCX has a 1.02 five-year beta, indicating it’s about as volatile as the broader market. At 0.94, DIA is slightly more defensive, while SPY’s 1.06 figure suggests it’s more volatile than usual. A key reason for these differences is Nvidia (NVDA), which FMCX outright avoids but comprises 6.72% of the S&P 500 Index.

2. FMCX has solid growth potential. Over the last five years, its selections have increased sales by 12.53% compared to 7.04% for DIA, and although the two ETFs have similar one-year estimated sales growth (6.66% vs. 6.15%), FMCX has a substantial edge on one-year estimated earnings growth (13.78% vs. 9.58%). On a sector-adjusted basis using Seeking Alpha Growth Grades, FMCX’s growth score is also better (5.27/10 vs. 4.40/10), which aligns with what we saw earlier in the performance analysis. FMCX outperforms DIA when growth stocks are favored, but disappoints in the opposite environment.

3. FMCX’s quality is excellent. The table reveals that most holdings have sector-adjusted profit scores of at least 9.25/10, corresponding to “A” or better, Seeking Alpha Profitability Grades. Overall, FMCX’s profit score of 9.36/10 is a substantial improvement over DIA and competitive with SPY’s 9.34/10 score, with only about half the exposure to the Magnificent Seven stocks (14.83% vs. 31.13%). Therefore, I accept the manager’s claim that its research process begins with identifying high-quality businesses.

4. Valuation is where things go sideways for FMCX. The fund trades at 25.85x forward earnings and 19.99x trailing cash flow, which are 6.49 and 3.77 points more than DIA. These valuations represent a significant premium for only 4% more extra earnings growth, and are likely unjustified. Compared to SPY, it’s impossible to make a “growth-at-a-reasonable-price” argument in favor of FMCX because it features almost identical growth metrics but trades 1–3 points more on forward earnings, trailing cash flow, and trailing sales. Finally, FMCX’s 2.55/10 sector-adjusted value score seals the deal. This score ranks #205/251 among the large-cap blend ETFs I track, and given the manager’s “high-conviction” approach, I doubt this will change anytime soon.

Investment Recommendation

FMCX is an actively managed large-cap blend ETF with a 0.70% expense ratio and $97 million in assets under management. First Manhattan is the investment adviser to the fund, and FMCX is managed by the firm’s Head of Research, an industry veteran with over 27 years of experience as a value-oriented investor. However, my analysis revealed that FMCX is better designed for growth investors, and its traditional valuation ratios were surprisingly high. While the fund’s quality is excellent, this is not unique for the category, and I believe low-cost Index funds like DIA and SPY will outperform over the long run. Therefore, I’ve assigned a “hold” rating to FMCX, and I look forward to your comments below. Thank you for reading.