Cinthia Murphy, Managing Editor, ETF.com
Many investors concerned about a global growth slowdown, geopolitical risk and the ongoing trade spat between the U.S. and China have turned to quality ETFs in an effort to mitigate some equity risk.
The idea of focusing on quality as a risk management tool is that companies with strong fundamentals should potentially weather a storm, such as economic slowdown or an earnings recession, better than companies with weak balance sheets.
The biggest quality ETF, the iShares Edge MSCI U.S.A. Quality Factor ETF (QUAL), has gathered $2.7 billion in net inflows year to date.
The fund, which measures quality of a company by looking for high return on equity (ROE), low debt/equity ratio and stable earnings growth, picks stocks within Global Industry Classification Standard sectors, avoiding active bets in the form of sector tilts or biases.
Helping QUAL is the fact that quality has been one of the top-performing factors this year. QUAL has outperformed the SPDR S&P 500 ETF Trust (SPY) year to date:
But QUAL, which has $10.6 billion in total assets, is only one of the quality ETFs finding traction. Other large funds include the Invesco S&P 500 Quality ETF (SPHQ), with $1.4 billion in assets, and the $2.7 billion WisdomTree US Quality Dividend Growth Fund (DGRW).
Each of these funds go about capturing quality in a slightly different way, and with different results. SPHQ, for instance, looks for high quality names in the S&P 500 using three measures: profitability as measured by ROE, earnings quality as measured by lower accruals, and earnings stability as measured by financial leverage.
A key difference between SPHQ and QUAL’s approach is that SPHQ has no constraints on sector weighting. It will own the highest quality stocks no matter what sector they’re in. That methodology often translates into big sector tilts. Consider that SPHQ currently has 60% of the portfolio in just two sectors: technology and health care.
DGRW, meanwhile, is really a dividend growth ETF, but one that captures quality through metrics such as ROE as well as historical data. Many investors turn to DGRW as a quality strategy that also shells out attractive dividends.
Charts courtesy of StockCharts.com
Each of these ETFs delivers on the quality factor, and they’ve all been successful in attracting investor attention. But they each go about it in a different way.
What they also offer is a reminder that knowing what’s under the hood in an ETF is crucial to making sure you are investing in the right product for your goals.
QUAL may offer purer quality exposure because the fund takes on no other significant bets or tilts, but it also comes with hefty valuations. Buying into the quality factor is getting expensive, and QUAL is at the top. SPHQ makes significant sector bets you might not be comfortable with, or they might be exactly how you view the market. And DGRW offers a strong growth angle at lower valuations, but it’s also the weakest performer of the three this year.
There’s no such thing as a one-size-fits-all quality ETF.
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