In Search for Quality, Focus on Free Cash Flow | ETF Trends

Among the various investment factors, definitions pertaining to quality are widely debated and not nearly as uniform as, say, growth, size, or value.

However, some of the hallmarks of quality companies include strong balance sheets. Obviously, one way to get to a sizable cash hoard while easily tending or eliminating debt is by generating significant amounts of free cash flow.

Among exchange traded funds, the FCF US Quality ETF (TTAC) is unrivaled in its emphasis on attractive free cash flow-generating traits. Hence, TTAC is also a credible part of the quality ETF conversation. Said another way, TTAC certainly has all-weather traits, but the ETF is increasingly relevant today as market participants fret about the shortening odds of a recession.

“While headline inflation continues to grind higher, hitting new multi-decade highs, investors are increasingly more worried about a potential recession. Buying quality is a typical reaction to an economic downturn. As investors become more cautious, they rotate towards companies best positioned to withstand a slowdown,” according to BlackRock research.

Two other traits highlight potential benefits with TTAC. The fund is actively managed and implements an environmental, social, and governance (ESG) focus into its stock selection process. Active management with an eye toward quality could be alluring because free cash flow as a singular index input could be tricky, and as noted above, there’s fluidity surrounding definitions of quality. Adding ESG to the equation also speaks to the advantages of active management.

Quality and free cash flow are also two traits that can help investors navigate tricky macroeconomic environments. That is to say even if a traditional recession doesn’t arrive, TTAC still has merit against the backdrop of rising inflation and four-decade high inflation.

“While these characteristics are likely to be valued during the current downturn, today’s circumstances are unique. Despite a cooling economy inflation remains at a 40-year high,” added BlackRock. “Stubbornly high inflation is both a drag on consumer spending and source of rising input costs. As a result, investors need to worry about both lower top-line growth and collapsing margins. Given these unique circumstances, investors should adjust their definition of quality to include another characteristic: pricing power.”

TTAC offers some inflation buffer by way of a nearly 26% weight to healthcare and consumer staples stocks. Likewise, a roughly 42% weight to growth sectors could prove beneficial in a recession.

For more news, information, and strategy, visit the Free Cash Flow 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.