This isn’t the time in the cycle to take excessive risk. The easy money has already been made. Astoria’s 2019 playbook is as follows: late cycle economic forces + desynchronized global growth + a deteriorating earnings cycle = the need for more defensive posturing across stocks and bonds.

Astoria has been vocal about owning higher quality stocks in 2019. Why? Companies with above average ROE/ROA and increasing profitability should be rewarded in an environment when earnings are declining.

Second, higher quality stocks have historically outperformed lower quality stocks (see chart below). Since 1963, the highest quintile of US profitable companies has returned 11.63% while the lowest quintile has returned 7.79%. Higher quality companies have also outperformed the market which returned 10.30% over this time-period.

Average Annual Returns

Source: Kenneth French Data Library, with data as of 12/31/17, WisdomTree. Period based on the availability of operating profitability returns sorted into quintiles, beginning 6/30/63. The universe is U.S.-listed equities grouped based on operating profitability. Past performance is not indicative of future results. Sharpe Ratio: Measure of risk-adjusted return. Higher values indicate greater return per unit of risk, specifically standard deviation, which is viewed as being desirable.

There are some key differences amongst Quality ETFs. Utilizing quantitative portfolio construction tools and aggregating the underlying fundamentals to determine the optimal ETF for your portfolio is crucial.

The key message from Astoria is to pick high quality stocks with strong balance sheets which have demonstrated the ability to grow their earnings regardless of the prevailing macroeconomic conditions. We find that DGRW (WisdomTree US Quality Dividend Growth ETF) and QUAL (iShares Edge MSCI USA Quality Factor ETF) have relatively higher factor loadings and have more balanced sector weights compared to some of the other larger Quality ETFs.

2019: The Year of the Quality ETF?

We were recently quoted in a CNBC article (click here) that Quality ETFs will take in more assets than any other factor category in 2019.

As of mid February, US listed Quality ETFs have taken in approximately $2 bln in assets. While this may not appear significant, the entire equity ETF universe has seen approximately $20 bln of outflows in 2019.

Astoria originally pegged quality as one of our key 2019 themes in our January 3rd blog (click here) and reiterated it our year ahead outlook on January 8th (click here). We like high quality stocks for the following reasons:

  1. The earnings cycle is deteriorating and companies with above average ROE/ROA and increasing profitability are likely to be rewarded more on a relative basis.
  2. The quality factor has historically shown to be robust, pervasive, and has been persistent over time.

We believe 2019 will be more defensively driven due to global growth becoming more desynchronized, the earnings cycle is deteriorating, late cycle economic forces, and elevated macro risks (trade tariffs, Brexit, China slowdown, etc.). See our recent CNBC interview (click here) or the Behind the Markets podcast with the Wharton School of Business (click here) where we reviewed our 2019 investment outlook.

DGRW and QUAL Have Outperformed the S&P 500 Over the Past 5 Years Despite a QE Induced Rally

Let’s dive deeper into the some of the larger Quality ETFs.

Source: Bloomberg

  • Over the past 5 years, the US economy has had varying periods of acceleration and slowdowns, but the general trend has been cyclicals outperforming defensives.

MSCI Cyclical vs Defensive Index

Source: Bloomberg

  • If high quality stocks performed well when the market was driven by QE and led by cyclicals, why wouldn’t quality work when the market shifts to a more defensive tone?

Not All Quality ETFs are Created Equal

As the Chief Investment Officer of Astoria, I have spent 20 years in the ETF ecosphere doing portfolio construction research, analyzing ETFs, and structuring portfolios for investors. Picking the right Quality ETF isn’t a trivial task.

Astoria has a unique value proposition in the ETF model portfolio space. We leverage extensive amounts of technology, software, and risk models to analyze the underlying ETF portfolio risk characteristics.

Amongst the 2 largest Quality ETFs, DGRW provides a slightly higher factor loading (RMW) compared to QUAL. There are 2 other ETFs, OUSA (O’Shares FTSE US Quality Dividend ETF) and SPHQ (Invesco S&P 500 Quality ETF), with a higher factor loading than DGRW.

RMW Factor Loading

Data Source: PortfolioVisualizer.com. (RMW) Robust Minus Weak: The profitability premium. Data retrieved on February 7th, 2019.

Below is a table showing the 5 factor loadings for the larger Quality ETFs.

Portfolio Visualizer

Data source: Portfolio Visualizer. Data for DGRW, QUAL, QDF, SPHQ, and QDEF is based on the time period August 2013 through December 2018. Data for OUSA and FQAL is based on the time period October 2016 through December 2018.

Comparing the 2 Largest Quality ETFs

DGRW (WisdomTree US Quality Dividend Growth ETF)

  • DGRW applies a quality and a growth screen when constructing the portfolio. In Astoria’s view, this is particularly attractive as we don’t necessarily think investors should be ignoring growth stocks but instead picking securities which have both growth and quality characteristics.
  • The earnings growth ranking is 50% of the portfolio construction process and is derived from companies’ long-term earnings growth expectations.
  • The quality ranking is the remaining 50% of the screening process and is split evenly between a three-year average return on assets (ROA) and the three-year average return on equity (ROE).
  • DGRW removes companies with higher dividend yields. The logic here is that if companies are paying out more than they earn, companies may have to cut back their dividends in the future.

DGRW Methodology

Source: WisdomTree

  • During the heightened volatility of Q4 2018, DGRW outperformed the larger Quality ETFs between 100-180bps (see chart below).

Select Quality ETFs

Source: Bloomberg

  • In our view, these are substantial return differences considering investors are quick to rotate amongst ETFs because of a few basis point difference in management fees.
  • DGRW’s top sector exposures are Information Technology (20%), Industrials (19%), and Consumer Staples (12%).

Top Sector Exposures

QUAL (iShares Edge MSCI USA Quality Factor)

  • QUAL tracks an index of US large and mid-cap stocks. The stocks are selected and weighted by high ROE, stable earnings growth and low debt/equity.
  • In our view, QUAL also has a sound methodology and has been the clear leader so far with $9 bln in assets in the Quality ETF space.
  • QUAL tends to be more concentrated with only 120 stocks or so.
  • There are some notable differences in the constituents and their weights for QUAL and DGRW so investors need to be comfortable with the portfolio risk characteristics when deciding between both ETFs.

QUAL Methodology

Source: ETFdb.com, Blackrock / iShares, MSCI.

  • QUAL’s top sector exposures are Information Technology (20%), Health Care (15%), and Financials (14%).

IT Communications Financials Sector Chart

Source: ETFAction.com

In the table below, we highlight some of the fundamental variables and sector weights for select Quality ETFs. Some factor ETFs will incorporate a quality metric in their screening methodology, but the focus isn’t quality per se. We’ve skipped those for the time being.

ETF Chart Ticker

Source: ETFAction.com. Refer to each of the ETF’s respective index methodology for more details.

Will ETF providers start to add the word quality to their ETF name in lieu of capturing what has been an emerging theme in just 6 weeks of this year? As someone who has worked in the ETF industry for 20 years, we wouldn’t be surprised.

Best, John Davi
Founder & CIO of Astoria

Warranties & Disclaimers

There are no warranties implied. Astoria Portfolio Advisors LLC is a registered investment adviser located in New York.  Astoria Portfolio Advisors LLC may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements. Astoria Portfolio Advisors LLC’s web site is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links. Accordingly, the publication of Astoria Portfolio Advisors LLC’s web site on the Internet should not be construed by any consumer and/or prospective client as Astoria Portfolio Advisors LLC’s solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice for compensation, over the Internet. Any subsequent, direct communication by Astoria Portfolio Advisors LLC with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

​For information pertaining to the registration status of Astoria Portfolio Advisors LLC, please contact the state securities regulators for those states in which Astoria Portfolio Advisors LLC maintains a registration filing.  A copy of Astoria Portfolio Advisors LLC’s current written disclosure statement discussing Astoria Portfolio Advisors LLC’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Astoria Portfolio Advisors LLC upon written request. Astoria Portfolio Advisors LLC does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Astoria Portfolio Advisors LLC’s web site or incorporated herein and takes no responsibility therefor. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. This website and information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy.  This website and information are not intended to provide investment, tax, or legal advice.

​Past performance is not indicative of future performance. Indices are typically not available for direct investment, are unmanaged, and do not incur fees or expenses. This information contained herein has been prepared by Astoria Portfolio Advisors LLC on the basis of publicly available information, internally developed data and other third-party sources believed to be reliable. Astoria Portfolio Advisors LLC has not sought to independently verify information obtained from public and third-party sources and makes no representations or warranties as to accuracy, completeness or reliability of such information. All opinions and views constitute judgments as of the date of writing without regard to the date on which the reader may receive or access the information and are subject to change at any time without notice and with no obligation to update. Any ETF Holdings shown are for illustrative purposes only and are subject to change at any time. This material is for informational and illustrative purposes only and is intended solely for the information of those to whom it is distributed by Astoria Portfolio Advisors LLC. No part of this material may be reproduced or retransmitted in any manner without the prior written permission of Astoria Portfolio Advisors LLC. Investing entails risks, including possible loss or some or all of the investor’s principal. The investment views and market opinions/analyses expressed herein may not reflect those of Astoria Portfolio Advisors LLC as a whole and different views may be expressed based on different investment styles, objectives, views or philosophies. To the extent that these materials contain statements about the future, such statements are forward looking and subject to a number of risks and uncertainties.

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