Fidelity Blue Chip Growth ETF: Has Market Sentiment Turned Positive? (BATS:FBCG)

Investment Thesis

Today, I will review for the second time the Fidelity Blue Chip Growth ETF (BATS:FBCG), a semi-actively managed ETF launched on June 2, 2020, and managed by longtime portfolio manager Sonu Kalra. As a quick recap, my first review concluded that FBCG follows an overly aggressive growth strategy that’s unlikely to appeal to most investors, especially given its high 0.59% expense ratio. Indeed, FBCG significantly declined in May and June but recovered nicely in July to become the best-performing large-cap growth ETF for the month. Therefore, this article aims to determine if the timing is right for growth investors to take on added risk. I feel it isn’t, but I’ll let the numbers do the talking as usual.

Performance Analysis

Since FBCG is a semi-actively managed ETF, there isn’t an Index it must follow. Instead, shareholders must rely on the skill of portfolio managers, which they can assess by analyzing their track record. Fortunately, we have lots of data to work with, given how a mutual fund using the same name and strategy launched over 30 years ago. Against the SPDR S&P 500 ETF (SPY), the ETF outperformed by an annualized 1.12% (11.15% vs. 10.03%) with identical risk-adjusted returns since 1993. In addition, its downside risk-adjusted returns (Sortino Ratio) were better, so overall, I think the long-term track record is strong.

Note: For presentation purposes, the following graph depicts FBCG’s returns to July 2020 and then backfills them with the Fidelity Blue Chip Growth No Load Fund’s (FBGRX) returns to maximize performance history. Readers may also be interested in the Fidelity® Blue Chip Growth Class K Retirement Fund (FBGKX). In both cases, they track FBCG reasonably well with fees being the primary difference.

Using a rolling three-year returns chart, we can see the many peaks and valleys the fund has experienced. Pay particular attention to the periods after major recessions, like 2009 and 2020-2021. During these periods of highly positive (and possibly irrational) market sentiment, FBCG tends to do best. For example, in the three years from March 2009 to February 2012, FBCG gained 122.58% compared to 97.41% for SPY. These periods of massive outperformance make FBCG attractive to risk takers. However, the critical step is anticipating market direction, which is very challenging.

FBCG gained 14.36% in July, making it the best-performing large-cap growth ETF on the market. Its three-month return is still near the bottom, but it may mean market sentiment is turning positive. Here are the returns for 26 large-cap growth ETFs I track. There are nine others in the category, but I didn’t include them because they have less than two years of history.

In addition to FBCG, I’ve highlighted the iShares Russell Top 200 Growth ETF (IWY) because it’s outperformed FBCG on nearly all periods measured but has a significantly lower five-year beta (1.10 vs. 1.31). I’ve written about IWY before, suggesting readers be ready to buy when market sentiment improves. Over the last three months, IWY has gained 0.95% compared to a 2.84% loss for FBCG, so even with FBCG’s leading July return, it’s still lagging most peers.

Furthermore, I don’t see a spark that justifies massive outperformance like in 2009 and 2020-2021. At least in those years, earnings surprises were huge (17.10% and 23.40%), and investors had reasons to be overly optimistic. However, the S&P 500 aggregate earnings surprise was only 6.1% in Q2, down from 7.3% in Q1. The average earnings surprise since Q1 2009 is 7.4%, so in my view, we’re still far from being in a risk-on environment.

FCBG Exposures

Fidelity doesn’t publish a daily holdings report. However, I’ve reviewed the list at the ETF Database, which resembles the tracking basket posted by Fidelity. Here are the top 20 as of June 30, 2022.

Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), and Alphabet (GOOGL) combine to total 36.89% of the ETF, making it an extremely concentrated ETF. NVIDIA (NVDA) and Tesla (TSLA) are next; in total, 67.29% of assets are inside the top 20.

The following table summarizes FBCG’s sector exposures, showing that Technology dominates at 41.83%. FBCG also overweights Consumer Discretionary (26.86%) and Communication Services (11.82%), while the remaining sectors receive minimal weighting.

Fundamental Analysis

I mentioned IWY earlier as a less risky alternative to FBCG. It’s also less costly with a 0.20% expense ratio and only slightly more concentrated. Along with its solid track record, I think FBCG shareholders should consider this fund, too.

The table below highlights selected fundamental metrics for FBCG’s top 20 holdings, with the rows at the bottom being metrics for the entire fund compared with IWY. Generally speaking, FBCG is far more volatile, but its constituents have better sales and earnings per share growth rates. EBITDA margins, surprisingly, are far worse, and both ETFs trade at valuations around 31.5x forward earnings. That’s very expensive, even more so than the Invesco QQQ ETF (QQQ).

Volatility

The highlight in this table is FBCG’s significantly higher 1.31 five-year beta. The primary reason is that FBCG overweights these five stocks:

1. Marvell Technology Group (MRVL): 3.18% vs. 0.00% = 3.18%
2. NVIDIA (NVDA): 5.42% vs. 2.68% = 2.74%
3. Meta Platforms (META): 2.77% vs. 0.52% = 2.26%
4. NXP Semiconductors (NXPI): 1.56% vs. 0.00% = 1.56%
5. Lowe’s (LOW): 1.79% vs. 0.72% = 1.07%

The average five-year beta for these five stocks is 1.43%, and a look at the graph of an equal-weighted portfolio confirms the added volatility. It also demonstrates the potential. This portfolio has gained at least 60% in four years since 2013 (2013, 2019, 2020, 2021). However, these stocks were the worst performers in the two negative years (2018 and 2022). You can view the results at this link for more detail.

In exchange, FBCG underweights the following five stocks:

1. Microsoft (MSFT): 9.43% vs. 12.92% = -3.49%
2. Apple (AAPL): 12.87% vs. 15.61% = -2.75%
3. Visa (V): 0.21% vs. 2.11% = -1.89%
4. UnitedHealth Group (UNH): 1.16% vs. 2.74% = -1.59%
5. Procter & Gamble (PG): 0.14% vs. 0.90% = -0.76%

These five stocks have an average beta of 0.83. Although the annualized returns weren’t as impressive as above (24.20% vs. 30.35%), the risk-adjusted returns, measured by the Sharpe Ratio, were far superior (1.60 vs. 1.23). This group is exceptional for getting the most bang for your buck.

Growth and Margins

FBCG’s constituents have grown sales at an annualized 20.59% over the last five years, which is best-in-class. Only the Invesco S&P 500 Pure Growth ETF (RPG) ranks better on this metric, so that’s clearly a key input into the managers’ selection process. Also, FBCG’s 21.88% estimated sales growth rate ties for the top spot with RPG. About 90% of the ETF’s weight is to companies with double-digit expected sales growth rates. Notable exceptions include NIKE (NKE), Dollar Tree (DLTR), and General Electric (GE).

While sales and earnings growth rates are strong, I was surprised to learn about FBCG’s relatively poor EBITDA margins. At 27.29%, it’s near the bottom of the category and comparable to the First Trust NASDAQ-100 Equal Weight ETF (QQEW). In both cases, the cause is the overweighting of speculative stocks like Uber Technologies (UBER). Uber lost $470 million on an EBITDA basis last quarter despite reporting net positive cash flow for the first time. I’m hesitant to call FBCG a speculative ETF given how its constituents are still financially strong overall, but it’s just one of the more riskier broad-based growth ETFs available.

Investment Recommendation

I can see how FBCG is an attractive ETF given its successful long-term track record. However, the large-cap growth ETF space is flooded with cheaper alternatives. Still, FBCG is in its own league with a category-high 1.31 five-year beta, and 21.88% and 24.79% estimated sales and earnings growth rates. I’ve found that this ETF tends to do best when quarterly sales and earnings surprises are abnormally high, but otherwise, it’s not worth the added risk.

Given the below-average 6.1% earnings surprise last quarter and the fact that IWY’s fundamentals still look reasonably strong, I don’t find FBCG to be a compelling buy. However, the Q2 earnings season was far from a disaster, and I think there’s more potential for growth stocks to rebound, so I am upgrading my rating from a sell to hold. I hope you enjoyed this review, and I look forward to answering any questions in the comments section below.