Although often compared with one another, the FCF US Quality ETF (TTAC) and the iShares Edge MSCI USA Quality Factor ETF (QUAL) have some fundamentally different approaches to how they construct their portfolios. As a result, a comparison of TTAC vs QUAL shows quite different returns.
The underlying Index for QUAL selects 100-150 companies that follow a sequential inclusion process based on return on equity, earnings variability, and debt-to-equity. TTAC uses FCF Advisors’ Free Cash Flow Quality Model, which selects roughly 150 stocks from Russell 3000 based on free cash flow profitability, quality of earnings, and cash flow-based financial strength indicators.
In addition, within the turnover constraints, TTAC makes more predictions with smaller active positions to reduce the variance of our predictive modeling. Plus, while QUAL follows a semi-annual rebalance at certain dates, TTAC processes new fundamental information to capture alpha signals in a timelier manner.
“As a result of its unique approach, TTAC has more exposure to information technology and energy companies than the sector-neutral QUAL while underexposed to communications services,” said Todd Rosenbluth, head of research at VettaFi. “With quality ETFs, the devil is often in the details.”
In a year-to-date match-up of TTAC vs QUAL, TTAC has outperformed QUAL by 868 bps.
TTAC aims to outperform the Russell 3000 through a fundamentals-driven investment process that selects about 150 stocks based on free cash flow strength. Its holdings are then weighted by a modified market-cap log transformation, allowing increased exposure to companies with the strongest proprietary free cash flow rankings.
Free cash flow is the cash a company generates after its cash outflows to pay expenses or support operations. Bob Shea, CEO and CIO of FCF Advisors, told VettaFi that his firm believes that while “GAAP earnings have significant disadvantages,” and “accounting practices allow a lot of leeway and discretion to management… The ability to manipulate and distort free cash flow is a lot more difficult than with earnings.”
“Free cash flow is so important right now, given that the allocation environment has gotten exponentially more difficult in 2022,” Shea said. “Cohorts have never seen an environment like this. In a difficult environment, people want to make sure they understand what they own.”
Shea also pointed out that FCF Advisors focuses on free cash flow profitability, which is operating cash flow after capital expenditures, rather than free cash flow yield, which compares free cash flow and market cap.
FCF Advisors specializes in free cash flow investment strategies, primarily through its Free Cash Flow Quality Model. They have been focused on free cash flow factors since 2011 and are specialized in multi-factor fundamental analysis grounded in decades of research.
For more news, information, and strategy, visit the Free Cash Flow Channel.