A Schwab Fund for Fundamental Value

01/27/2020 5:00 am EST

Focus: FUNDS

Todd Rosenbluth

Senior Director of ETF & Mutual Fund Research, CFRA Research

Our latest Focus Mutual Fund, Schwab Fundamental US Large Company Index Fund (SFLNX), is rated favorably based on a combination of holdings-based analysis and a review of its relative performance and costs, explains Todd Rosenbluth, an analyst with CFRA Research's The Outlook.

SFLNX outperformed its large cap value peer group the last five calendar years and year-to-date through December 13. This fund outperformed during the favorable recent years for value strategies (2016 and 2017) and unfavorable ones (2015 and 2018).

On a three-year annualized basis, the fund’s 11.5% total return was ahead of the 9.8% peer average at the end of November, despite an in-line standard deviation. Yet, unlike many of its actively managed peers, SFLNX is index based.

The fund seeks to replicate a Russell RAFI US Large Company index that selects and weights securities based on three fundamental measures of company size: adjusted sales, retained operating cash flow and dividends plus buybacks. The fund’s 10% turnover rate, well below the 62% peer average, highlights the passive nature of the strategy.

SFLNX holds many securities that are viewed as attractively valued by CFRA equity analysts. There are more than 700 securities in the fund with the top-10 holdings representing 20% of assets. CFRA buy-recommended Apple (AAPL), AT&T (T), Chevron (CVX), General Electric (GE), JPMorgan (JPM) and Walmart (WMT) are among the fund’s largest positions.

While the widely followed Russell 1000 Value index holds a similar number of securities and has 22% of assets tied to the top-10, AAPL and MSFT are not represented in that benchmark as they are deemed growth, not value, stocks by Russell.

At the sector level, SFNLX’s 17% stake in Information Technology stocks is higher than the Russell index’s 6%, while the fund’s exposure to Financials (15% vs. 24%) is relatively muted.

Beyond JPM, the mutual fund owns Bank of America (BAC), Citigroup (C) and Wells Fargo (WFC) in the sector. However, the weights are not the same as in the index, with SFLNX owning smaller stakes in each of the banks.

The fund’s 0.25% expense ratio is also well below the peer average of 1.01%, contributing favorably to CFRA’s star rating, and has shrunk from 0.35% three years earlier. There is $5.4 billion in assets in the mutual fund, up slightly from a year ago, but consistent with levels in 2016 and 2017.

Despite its strong record, low costs and appealing portfolio, investors have focused more on an ETF version of the same strategy.

Schwab Fundamental US Large Company Index ETF (FNDX) — which CFRA rates independently from SFNLX — has $6 billion in assets, aided by $1.7 billion of net inflows since the beginning of 2018. CFRA Research rates this ETF as "Overweight ".

Rather than basing our fund rankings solely on past performance, CFRA incorporates a more holistic three-tiered approach, reviewing performance analytics, risk considerations and cost factors.

Considering the advanced age of the current bull market, some investors are naturally getting nervous about the potential for a market correction – an important reason to consider risk.

As an input to the CFRA Risk Considerations score — which are positive for SFNLX — CFRA notes that the S&P Global credit rating for the underlying holdings is generally strong, on average.

The manager tenure is also a positive; the management team has been in place since the beginning of 2013. CFRA also notes the positive input from the Sharpe ratio (0.80 vs. 0.70 for peers).

The Sharpe ratio quantifies the return of an investment strategy in excess of the risk-free rate relative to its volatility. A higher Sharpe ratio, combined with a lower standard deviation, indicates a strategy is producing strong returns relative to the risk that is being incurred.

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