SCHG: Growth Isn't Slowing Down, Value Isn't Catching Up (2024)

Introduction

The Schwab US Large-Cap Growth ETF (NYSEARCA:SCHG) seeks to capitalize on "factor investing," which is selecting investments based on certain criteria and behavior that the investments present. Specifically, for SCHG, it looks to capitalize on the market cap and value/growth factors by selecting companies (as the name of the fund implies) that are large-cap and exhibit the growth factor. More on that in a later section.

The fund is exemplary for broad-market ETFs: it has an expense ratio of 0.04% annually, has low turnover of 4.3%, distributes dividends quarterly, and has a very large AUM that has made its longevity clear to investors.

Since inception, the fund has outperformed the S&P 500, particularly since 2020.

Compared to growth's counterpart, value, we can see an even greater level of outperformance. This outperformance has been largely driven by the rise of "FAANG" companies and then the "Magnificent Seven," which are primarily growth stocks.

Holdings

SCHG still holds many of these stocks, with its largest holdings being all the Magnificent Seven stocks.

Factor Investing

So, with this past performance and current composition in mind, should we expect this to continue?

Kenneth French, one of the two scholars who discovered and popularized factor investing, keeps active records of the performance of these factors when isolated. He has tracked these all the way back to 1926 and can show how each factor has returned in isolation since then.

We have seen a stagnation in the SMB (or "small minus big") factor, which should tell us that small caps outperform large caps on average.

This chart only goes to 2019, but we can see a continued divergence between indices that are based on these factors, such as the difference between the Russell 1000 and the Russell 2000, which tracks large and small cap companies in the US respectively.

After having stagnated for some time, it's clear that large caps are still outperforming small caps, which have been fairly stagnant since 2021.

This extends to the value factor as well, which has stagnated tremendously over the last two decades. This factor is categorized as "HML" or "high minus low book value." It peaked in 2008.

Again, this chart ends in 2019, but we can plot ETFs that follow these factors since then to show the continued outperformance of growth over value.

I believe that the changes made to monetary and fiscal policy in the US (and around the world) since 2008 have changed the paradigm of value vs growth and small vs large caps. The rise of monopolistic companies like those in groups such as FAANG and the "Mag 7" also contribute to this shift.

Because of this shift, we should expect continued outperformance of these two factors over their historically advantageous counterparts, so long as the default for central banks is quantitative easing and large companies are allowed to acquire en masse (e.g. Google), squeeze consumers into ecosystems that are difficult to leave (e.g. Apple), and build marketplaces that they themselves are allowed to compete in (e.g. Amazon).

Place in a Portfolio

SCHG operates as a core component of a portfolio, and can be used as a primary means of equity exposure. It carries a beta of 1, meaning that it has basically the same return profile as the general market day-to-day. The difference is going to be in the exclusion of lesser performing factors like growth and small caps.

There are funds aiming to give exposure to the opposite factors, which may outperform in the future if we see a paradigm shift back to old monetary and fiscal policy, which had enabled the previous outperformance of small-cap and value companies prior to 2008.

My pick for a complimentary fund would be the Avantis U.S. Small Cap Value ETF (AVUV). This fund actively invests in the opposite factors of SCHG and is one of the least correlated funds, which should provide real diversity of holdings to investors.

The fund also pairs well with traditional diversifiers such as bonds and managed futures, which have very low correlations to SCHG and its return profile.

If I were wanting to pair SCHG with another broad equity fund, I would target another factor: low volatility. The low vol factor sorts stocks by their standard deviations and only picks out the lowest volatility investments.

Interestingly enough, this has been something of an investing paradox. The lowest volatility stocks tend to outperform the highest volatility stocks in the long term.

SCHG, which owns middle to high volatility names (as growth stocks tend to be more volatile than value stocks on average), would benefit from a low volatility counterpart in a portfolio. This could be a fund like the iShares MSCI USA Min Vol Factor ETF (USMV).

Suitability

SCHG is suitable for most investors, but should be considered riskier than a broad-market index fund that includes the other aforementioned factors, such as the Vanguard Total Stock Market Index Fund ETF (VTI) or the geographically diverse Vanguard Total World Stock Index Fund ETF (VT).

SCHG could be used as a core equity holding on its own, but only for aggressive investors who seek the higher risk of the growth and large size factor. To reduce risk, one should add one of the aforementioned complimentary funds like AVUV or USMV as they will capture the gains of a factor rotation if growth and large-caps began to underperform for whatever reason.

For the conservative investor, SCHG should be used as a satellite to a broader index fund, potentially serving as less than 20% of an equity allocation.

Conclusion

The Schwab US Large-Cap Growth ETF is an index fund that has proven itself as able to capture the new paradigm shift in factor investing that has played out over the last fifteen years. Small caps and value have fallen to the wayside as FAANG and the Magnificent Seven have proven superior investing strategies. The best way to capture these trends is through US large-cap growth, i.e., SCHG.

Investors should exert some caution with how heavy they rely on SCHG in a portfolio as another paradigm shift could leave SCHG behind while other factors such as small-caps, value, and low volatility outperform. Factors can be cyclical, so it is important for investors to not rely too heavily on one for too long.

Thanks for reading.

John Bowman