A new ETF that tries to identify high-quality companies uses many of the same investing principles as Warren Buffet.
“Does the newly launched iShares MSCI USA Quality Factor (NYSEArca: QUAL) capture some of Buffett’s essence? I dare say it does. Now, I’m not claiming you’re going to get Buffett-like results by owning this fund. It’s a pale imitation of the real thing,” writes Morningstar ETF analyst Samuel Lee in a commentary posted on the firm’s website Friday. “However, it’s clear that MSCI took its inspiration from all the right places when it devised the index.” [iShares Launches ‘Quality Factor’ ETF]
BlackRock launched QUAL in July. The fund is one of four ETFs the firm has introduced that weight individual companies by economic factors, rather than by market capitalization like most traditional stock benchmarks. [Fundamental ETFs Rising]
So-called fundamentally weighted ETFs are becoming more popular. They focus on dividends, earnings, debt levels and other factors. [Schwab to Launch Its First Fundamentally Weighted ETFs]
Many fundamentally weighted ETFs are designed to outperform traditional equity indices on a risk-adjusted basis. [A Market-Beating Fundamental ETF]
For example, QUAL tracks an index designed by MSCI comprised of large and mid-cap stocks that are selected based on three fundamental factors: return on equity, earnings variability and debt-to-equity. The ETF charges an expense ratio of 0.15%.
Next page: ‘Common-sense interpretations of Buffett’
Morningstar’s Lee points out that Buffett’s criteria for acquisition include good returns on equity, little or low debt and consistent earnings power.
“The index’s selection rules are simple, common-sense interpretations of Buffett’s criteria,” the analyst wrote.
“This by itself doesn’t mean the index can capture Buffett’s magic. (It can’t.) Buffett takes into consideration valuation, managerial quality, and his assessment of the industry’s future dynamics, among other things,” Lee added. “He doesn’t make many purchases, and when he does he keeps them, whereas this index buys more than a hundred companies and can churn them during its semiannual rebalances. The best that can be said is that if Buffett buys the needle, the index buys the haystack. However, that need not invalidate the strategy, because it’s buying the haystacks where Buffett tends to find needles.”
He said Vanguard Dividend Appreciation (NYSEArca: VIG) is another ETF that adopts Buffett’s precepts.
“VIG works because it buys quality stocks, which have economic moats that enable them to grow their earnings (and dividends) through thick and thin,” Lee writes. [These ETFs Focus on Quality Companies with High Profitability]
Finally, Market Vectors Wide Moat ETF (NYSEArca: MOAT) is yet another ETF that tries to incorporate Buffett’s approach.
Full disclosure: Tom Lydon’s clients own MOAT.