After junkier stocks led the cyclical value rally earlier this year, quality stocks are getting a second look, and that has positive implications for exchange traded funds, such as the Invesco S&P 500 Quality ETF (NYSEArca: SPHQ).
The truth is, quality stocks rarely go out of style. After all, what’s not to like about stocks with impressive return on equity, accruals ratio, and financial leverage ratio traits — the metrics employed by the S&P 500 Quality Index, SPHQ’s underlying benchmark.
That straightforward approach is relevant to investors because more than any other investment factor, there’s fluidity in how the investment community views quality. With SPHQ, investors gain an accessible, easy-to-understand approach.
“Quality metrics are popular in the practitioner investment community, but no standard definition for the quality factor has been agreed on. In contrast, factors such as value and size have clear and accepted definitions. Although an extensive literature is dedicated to a few specific facets of quality, certain facets used in practitioner definitions have been only minimally explored in the academic literature,” according to a paper in the Financial Analysts Journal authored by Jason Hsu, Vitali Kalesnik, and Engin Kose.
SPHQ an Exclusive Club
As noted above, SPHQ tracks a benchmark that’s an offshoot of the S&P 500. That doesn’t mean investors that can buy an S&P 500 index fund and get a heaping dose of quality stocks. Actually, the opposite may be true because SPHQ is exclusive territory, being home to just 102 of the 500-plus S&P 500 members.
Interestingly, a case can be made that quality, though it’s an individual factor, is actually a multi-factor concept.
“Leading quality index products provide a collection of heterogeneous attributes linked by the theme of financial and accounting quality. No evidence exists that these variables proxy for a unique homogeneous source of risk or a single anomaly. Therefore, quality indexes are more appropriately interpreted as multifactor portfolios whose primary commonality is that they are constructed mostly from the less well-known and less vetted company characteristics,” note Hsu, Kalesnik, and Kose.
What the researchers mention isn’t surprising. Quality is often conflated with low volatility and a look at SPHQ’s lineup reveals nearly equal distribution among growth and value equities.
Given the murkiness surrounding quality’s definition, some investors may find it easier to focus on sector-level quality. SPHQ obliges. For example, the fund is lightly allocated to energy and real estate names — two capital-intensive groups. Conversely, the Invesco fund allocates over 37% of its weight to tech stocks.
For more news, information, and strategy, visit the ETF Education Channel.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
