Key Takeaways

  • Fidelity Quality Factor ETF (FQAL) earns a CFRA five-star rating based on its strong performance record, appealing holdings, and its moderate expense ratio.
  • The fund takes a sector-neutral approach focused on free cash flow and return on invested capital. Eight of its recent top-10 holdings are undervalued to CFRA Equity Analysts.
  • CFRA expects FQAL to outperform its U.S. equity ETF peers over the next nine months.

Fundamental Context

The CFRA Focus ETF for January is Fidelity Quality Factor ETF (FQAL). The fund earns a five-star rating from CFRA, based on a combination of its risk, reward, and cost attributes and using portfolio-level and fund-specific analysis. Rather than solely relying on past performance to offer a star rating on U.S. equity ETFs, CFRA also offers a forward look at the stocks inside and the fund’s costs. In contrast, the ETF is rated a four-star by Morningstar, which relies solely on its past performance.

The proprietary index behind FQAL takes a sector-neutral approach and focuses on free cash flow margin to gauge whether or not a company has high earnings quality, on free cash flow stability to measure consistency, and on return on invested capital to assess profitability. This is different than some other quality focused ETFs that can be overweighted to certain sectors and/or focus on debt leverage. Given the likely slowing industrywide for earnings growth in 2022, we think investors will benefit from a diversified basket of higher quality companies.

Within the Information Technology sector (29% of assets), the fund owns Apple (AAPL), Microsoft (MSFT), and NVIDIA (NVDA), which are all CFRA Buy or Strong Buy recommended. Health Care (13%) and Consumer Discretionary (12%) positions include CFRA Strong Buy recommended Pfizer (PFE) and UnitedHealth Group (UNH), as well as CFRA Buy recommended Lowe’s (LOW) and McDonald’s (MCD). Overall, eight of the fund’s recent top-10 holdings were viewed as attractive to CFRA’s fundamental equity analysts. Meanwhile, nine of the top-10 ETF holdings had strong earnings quality scores according to CFRA’s forensic accounting analysis.

The index behind FQAL is rebalanced semi-annually with the next one occurring in mid-February. The fund’s recent annual turnover of 35% confirms that positions can shift. For example, the fund added Applied Materials (AMAT) and Merck (MRK) during the August rebalance, while removing Edward Lifesciences (EW) and FLEETCOR Technologies (FLT).

FQAL is an under the radar quality ETF that performed well in 2021. FQAL rose 32% in 2021, outperforming the 29% for the S&P 500 Index as well as the returns of some more popular smart-beta ETF peers. The $25 billion and CFRA five-star rated iShares Edge MSCI USA Quality Factor ETF (QUAL) and the $3.6 billion and five-star rated Invesco S&P 500 Quality ETF (SPHQ) rose 27% and 28%, respectively, in 2021. FQAL ended 2021 with $260 million in assets, despite also outperforming both QUAL and SPHQ over the past five years (18.2% vs. 18.1% and 17.3%, respectively). While FQAL’s expense ratio of 0.29% is slightly above peers, we think investors have and are likely to continue to benefit in 2022. FQAL has higher reward potential and incurs less risk than its high quality peers and the broader U.S. equity category according to CFRA’s star-rating process. We think investors should be more aware of FQAL and the broader smart-beta suite Fidelity offers.

Todd Rosenbluth is Director of ETF & Mutual Fund Research at CFRA.

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