As Managing Editor of The Wealth Advisor, I recently had the opportunity to sit down with Matt Cohen, Senior ETF Specialist at Principal Asset Management. Our conversation revolved around an often-overlooked yet crucial aspect of portfolio construction: the role of mega-cap stocks in today's market landscape.
Cohen shed light on Principal's innovative approach to mega-cap investing, embodied in their USMC ETF. This fund, priced at a competitive 12 basis points, aims to provide investors with focused exposure to the largest companies in the U.S. market.
Redefining Mega-Cap
Principal defines mega-cap as the top half of the S&P 500 by market valuation. Cohen emphasized that these companies typically boast strong balance sheets, durable earnings, ample liquidity, and significant brand awareness. These characteristics often translate into better downside protection during market turbulence.
"Our belief is these companies have strong balance sheets, durable earnings, ample liquidity, and most importantly brand awareness," Cohen explained. "We think you should be overweight some of these names because of the quality characteristics and, more importantly, potentially over those last three decades that downside protection they offer."
The USMC Approach
The USMC ETF takes an intriguing approach to portfolio construction. It includes the top 42 companies by market cap but employs an equal-weight methodology with a twist. The top 10% of holdings (currently Apple and Microsoft) are market-cap weighted to avoid unintended risk, while the remaining positions are equal-weighted with slight tilts based on financial strength and volatility metrics.
This methodology allows the fund to capture the stability of mega-caps while potentially enhancing returns through rebalancing. Cohen cited Nvidia as an example, explaining how the fund's active management component allowed them to take profits during the stock's remarkable run-up.
Addressing Common Pitfalls
One of the most compelling aspects of our discussion was Cohen's insight into common portfolio construction mistakes. He pointed out that many large-cap managers inadvertently underweight mega-cap stocks in favor of mid-cap names. In fact, Cohen noted that on average, 20% of large-cap blend managers' portfolios consist of mid-cap stocks.
This style drift can lead to unintended risk and potentially suboptimal performance. The USMC ETF aims to solve this problem by providing pure mega-cap exposure, allowing advisors to precisely control their large-cap allocation.
The New Core?
As our conversation progressed, it became clear that Cohen views USMC as a potential core holding for many portfolios. When asked about allocation strategies, he suggested that USMC could comprise anywhere from 25% to 40% of a total portfolio, or about 50% of the large-cap allocation, depending on individual circumstances.
"I don't think our compliance department would want me to put a number on it," Cohen said, "but I would say it ultimately should be 50% of your large-cap portfolio."
This aggressive stance underscores Principal's confidence in the mega-cap thesis. It's worth noting that while this allocation suggestion is intriguing, advisors should always consider their clients' individual needs and risk tolerances when making portfolio decisions.
Beyond Performance: A Fee Management Tool
One of the most compelling arguments for USMC is its role in overall portfolio fee management. At just 12 basis points, it's priced competitively with passive index funds while offering an active management component.
Cohen suggested that advisors could use USMC to bring down the overall fee structure of their portfolios, freeing up "fee budget" for more expensive allocations like alternatives, international stocks, or small-caps.
