ETF Pulse Check Navigating Volatility with First Trust SMID Capital Strength ETF

The First Trust SMID Capital Strength ETF (FSCS) is strategically positioned within the mid-cap US equities landscape, focusing on the SMID Capital Strength Index. This ETF aims to capture dividend-paying mid-cap stocks that have demonstrated resilience and capital strength. FSCS operates by excluding non-dividend-paying stocks over the past year, aligning sector weights with its market-cap-weighted parent index, the NASDAQ US 600 Mid Cap Index. Through quarterly rebalancing and reconstitution, the ETF ensures that sector allocations are equal-weighted, thus underweighting larger stocks compared to market-cap-weighted indexes. This approach is particularly relevant in the current market environment, where investors seek stability amid economic volatility and geopolitical tensions.

Basic Information
The First Trust SMID Capital Strength ETF, with the ticker FSCS, is managed by First Trust Advisors L.P. and was launched on June 20th, 2017. The ETF carries an expense ratio of 0.60%, reflecting its cost structure. Currently, the top 15 holdings include Interparfums (1.19%), The Buckle (1.19%), Trimble (1.18%), Dynatrace (1.18%), and Visteon (1.18%), among others. Sector exposure is primarily concentrated in Consumer Discretionary (4.74%), Industrials (4.57%), Financials (3.46%), Information Technology (2.36%), and Health Care (2.25%). Recent net flow ratios show a 7-day net flow of 0.00% and a 30-day net flow of 0.20%. The ETF's average returns over 6 months, 1 year, and 3 years are -0.34%, 6.22%, and 1.69%, respectively, with volatility levels reflected in return standard deviations of 3.85%, 8.05%, and 8.64% over these periods. The maximum return drawdown is notable at 0.99% for 1 year and 1.00% for 3 years.

News Summary
Recent news highlights affecting the ETF and its sector exposures emphasize several key themes. The Consumer Discretionary sector, a significant portion of FSCS's holdings, is facing critical opportunities and challenges, with macroeconomic factors such as interest rate dynamics and policy risks playing a pivotal role. Notably, President Trump's termination of trade talks with Canada over digital services tax, and California Governor Newsom's lawsuit against Fox News for defamation, underscore geopolitical tensions that could impact market sentiment. Additionally, the sector's performance is seen as a barometer of consumer confidence, with key companies like Nike and Starbucks navigating strategic challenges and expansion opportunities. The sector ranks #10 according to the Zacks Sector Rank, indicating mixed performance amidst evolving market conditions.

Analyst Rating: Sell
The First Trust SMID Capital Strength ETF presents several concerns that warrant a "Sell" rating from analysts. The high expense ratio of 0.60% suggests a less competitive fee structure, impacting overall investment value. Capital flow analysis reveals tepid investor interest, with negligible 7-day net flow and modest 30-day positivity. Return metrics are lackluster, with negative returns over 6 months and suboptimal growth potential over longer periods. Volatility measures, with standard deviations exceeding 8%, indicate heightened risk exposure, while concentration within the top 15 holdings mitigates single-sector risks but could also lead to increased volatility. Despite commendable premium stability and diversification, the ETF's financial performance and cost structure are concerning.

Backtest Scenario
A backtest of the First Trust SMID Capital Strength ETF from June 2020 to June 2025, focusing on consumer discretionary sector volatility, reveals resilience amid sector fluctuations. FSCS managed to navigate the volatility within the consumer discretionary sector effectively, with a balanced return profile that aligns with its focus on capital strength and mid-cap stocks. Norwegian Cruise Line and Smurfit Westrock experienced declines due to industry-specific challenges, while Ralph Lauren outperformed, driven by strategic international growth. FSCS's volatility management strategy has demonstrated stability, achieving a market price increase of 10.88% and index performance of 10.44%, despite sector-specific risks.

Risk Outlook
Looking ahead, FSCS faces several risks attributed to macroeconomic and sector-specific factors. The fund's exposure to the consumer discretionary sector remains vulnerable to shifts in consumer spending and confidence, particularly amid interest rate fluctuations and policy changes. Trade tensions between the US and Canada could further strain cross-border activities, impacting companies within the ETF reliant on international markets. Persistent inflationary pressures may lead to rising input costs for manufacturing holdings like Watts Water Technologies and Trimble, compressing margins. Concentration risks are present due to significant weight in the top 15 holdings, with potential volatility arising from supply chain disruptions affecting companies like Visteon. Overall, liquidity risks appear stable but could escalate amid broader market volatility.

Conclusion
The First Trust SMID Capital Strength ETF presents a complex investment case, suitable for conservative investors seeking stability amid sector volatility. While its strategic sector focus offers potential for balanced returns, ongoing monitoring of macroeconomic risks and sector-specific challenges is crucial for informed investment decisions.