Long-term investors may turn to exchange traded funds that target quality stocks to capture attractive returns over time, and people may find cheaper valuations after the recent market pullback.
“Good companies don’t always make good investments, but they may offer attractive returns relative to the market over the long term when they are trading at reasonable valuations, as they are now,” writes Alex Bryan, an equity strategies analyst at Morningstar.
For instance, the iShares MSCI USA Quality Factor ETF (NYSEArca: QUAL) tracks large- and mid-sized U>S. stocks with high returns on equity, low debt-to-capital ratios and low variability in earnings growth over the previous five years relative to sector peers. Consequently, the portfolio leans toward stocks with durable competitive advantages, Bryan said.
QUAL holdings typically hold up slightly better during market downturns. They don’t retreat as much as high growth stocks since their strong competitive advantages help shield profits and make the firms less sensitive to business cycles. For instance, during the bear market from 2007 to early 2009, QUAL’s underlying MSCI USA Sector Neutral Quality Index decreased 47% while the MSCI USA Index plunged 54.7%.
However, due to its more defensive nature, these types of companies may underperform during strong market rallies when growth stocks take over.