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How to Quantify Quality in an ETF

The quality factor has been in the spotlight this year as investors eschew riskier fare. That movement is benefiting exchange traded funds such as the PowerShares S&P 500 High Quality Portfolio (NYSEArca: SPHQ ) .

The quality factor is a point of emphasis for a growing number of strategic beta exchange traded funds. Though there has been debate surrounding defining quality as it pertains to factor-based investing, quality companies and dividend-paying stocks often go hand-in-hand because those dividends are seen as signs of stable earnings and thoughtful management.

While the quality and value factors often appear together across various stocks and ETFs, that should not be interpreted to mean that all quality stocks and ETFs are discounted relative to the broader market.

Related: A Quality Alternative

SPHQ follows the S&P 500 Quality Index. While the quality and value factors often appear together across various stocks and ETFs, that should not be interpreted to mean that all quality stocks and ETFs are discounted relative to the broader market. During periods of elevated market volatility, the quality factor has historically posted better returns relative to other investment factors.

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"The Index tracks the performance of stocks in the S&P 500 Index that have the highest quality score, which is calculated based on three fundamental measures, return on equity, accruals ratio and financial leverage ratio. The fund and the index are rebalanced and reconstituted semi-annually on the third Friday of June and December," according to Invesco PowerShares, the fourth-largest U.S. ETF issuer.

Valuing high quality value is particularly important as bull markets enter their waning stages, as some market observers believe the current bull market is doing. In the early stages of bull markets, lower quality companies see their shares soar. However, as the bull matures, investors often exhibit a preference for higher quality fare with more compelling valuations.

Related: 3 High Octane Value Trades for a Bear Market

"In recent years high quality stocks have outperformed the S&P 500 index. These companies are by definition less risky and better equipped to survive tough economic periods. The stocks reflect this by typically exhibiting less volatility than the market as a whole. Quality reflects many of the ideals of legendary investor Warren Buffet which is buying '… wonderful companies at a fair price," according to Investopedia.

For more information on Equity ETFs, visit our Equities category .

PowerShares S&P 500 High Quality Portfolio (NYSEArca: SPHQ )

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article was provided by our partner Tom Lydon of etftrends.com.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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