SCHB is a $23.2 billion fund with a mixed equity blend that is supposed to encompass two echelons of the U.S. market.
With a microscopic expense ratio of just 3 bps, SCHB is one of the cheapest passively managed investment vehicles available to U.S. investors.
My point is that SCHB’s diversification is mostly illusory, as it is top-heavy, with an almost perfect correlation with IVV, SPTM.
Laser1987/iStock Editorial via Getty Images With a hefty portfolio, microscopic expense ratio, and single-digit turnover, Schwab U.S. Broad Market ETF ( SCHB ) looks like a perfect core long-term holding for passive investors who set high standards for diversification and risk dispersion, while being completely intolerant of high costs gradually eating away their initial investment over the course of years. That might be true upon cursory inspection, as the portfolio of 2,501 total holdings is nothing short of impressive.
However, SCHB’s returns are highly correlated with the iShares Core S&P 500 ( IVV ) and SPDR Portfolio S&P 1500 Composite Stock Market ( SPTM ) ETFs, which is clearly illustrated by the historical data discussed below in the article.
Moreover, it has a similar amount of net assets deployed to just ten key holdings, with an unsurprising tilt towards mega-caps. As a direct consequence of being overweight in large caps, it also has solid quality if measured using factors that lie at the crux of the Quant Profitability grade, though a measly dividend yield.
Additionally, the spread between the weighted-average market cap and the median figure allows us to quickly assess if a fund has a top-heaviness problem (hence, poor risk dispersion). SCHB’s median market cap stands at ~$3.85 billion , while the weighted average is approximately $540.2 billion , as of my estimates. The corollary here is that the fund clearly relies too much on just a few main holdings.
Regardless, I am by no means arguing against investing in SCHB solely because it performs almost entirely like IVV or SPTM due to holdings overlap.
Contrarily, the fund might still be a solid long-term choice, assuming its 3 bps expense ratio. However, my point is that SCHB’s diversification is rather illusory, and holding a blue-chip-tracking ETF together with a so-called broad-market fund in one portfolio to reduce risks does not make sense.
Now, let us dig in and discuss its investment strategy, valuation, quality characteristics, returns, and more. Investment strategy
Incepted in November 2009, SCHB opted for tracking the float-adjusted market-cap-weighted Dow Jones U.S. Broad Stock Market Index . The index is rebalanced in March, June, September, and December, as mentioned in the factsheet .
Please, take notice that the index provider designed this benchmark to track the large-cap and small-cap echelons, with medium-sized companies excluded for some reason. This is what makes it distinctively different from the parent – the Dow Jones U.S. Total Stock Market Index.
By all means, index management has limitations, and SCHB cannot ignore the mid-cap universe all the time, as market values are constantly fluctuating. In the SCHB holdings dataset from November 26, I found 1,005 mid-caps (market values from $2 billion to $10 billion) with a combined weight of ~8.6%. So please keep in mind that by investing in SCHB, you also inevitably get exposure to the mid-cap echelon, though rather minimal.
Another important notice is that some differences between the index constituents and actual SCHB’s holdings might emerge from time to time. As the fund clarified in the prospectus , it can purchase securities or dispose of them in case their removal/addition is in the cards. This certainly has one purpose: to track the benchmark as closely as possible. Dissecting the portfolio
As I said above, there is a panoply of equities inside the SCHB portfolio. However, the main ten holdings account for ~24.7% , a level below IVV’s by almost 5%, but still not ideal given such impressive depth of exposure. Alas, something different should not be expected from the fund tracking a market-cap-weighted index. More or less, the mega-cap league members will still be at the very top, influencing returns grossly.
Besides, its sector exposure is similar to the one U.S. investors have certainly gotten accustomed to: the IT names dominating the mix, boasting almost 28% weight, with consumer staples (close to 13%) and healthcare (~12.6%) in second and third places. It goes without saying that IVV and SPTM, which I discussed in greater detail in the article published in October, have precisely the same asset allocation pattern.
Now, turning to holdings overlap . Holdings overlap is a significant risk sometimes, […]