At the end of the first quarter, the S&P 500 posted a 7.5% gain, yet many advisors think there’s a limit to the upside for equity markets in 2023. At the end of March, VettaFi hosted a webcast with Innovator ETFs, during which we asked, “Where is the S&P 500 likely to be at the end of 2023, relative to the end of 2022?” The most popular selection was flat (40%), followed by 10% higher (39%).
The favorable news is that only 16% of respondents believed the market would end 2023 lower than it started the year. Yet very few seemed to believe the strong gains achieved in the first three months were likely to persist, while many think we could essentially tread water for the next nine months.
In the first quarter, many investors turned to ETFs that invest in higher quality companies with strong financial profiles such as low debt leverage, consistent earnings, and ample free cash flow generation. Let’s review some of them, including what they own.
The iShares MSCI USA Quality Factor ETF (QUAL) pulled in more money than any ETF in the first three months of 2023 — $7.2 billion — even as industrywide U.S. equity ETFs had net outflows. Most of this money moved into QUAL on March 20, when a large institutional investor appeared to shift away from an iShares ESG ETF in attempt tilt toward equity risk reduction favoring large- and mid-cap stocks amid a shifting macroeconomy and the impact of the bank failures on monetary policy.
QUAL owns companies with high return on equity, stable year-over-year earnings growth, and low financial leverage, but also seeks to have a similar risk profile to the broader MSCI USA Index. Information technology is the largest sector (23% of assets) but is soon followed by financials (16%). Visa (V) and Mastercard (MA), which recently became classified as financials, are two such top-10 holdings in QUAL.
The Pacer US Cash Cows 100 ETF (COWZ) owns the 100 companies from the Russell 1000 Index that have the highest free cash flow yield. Free cash flow is what a company has left of its revenues after operating and capital expenses are paid. This money can be used for share buybacks, to pay dividends, or to make acquisitions. Energy (36% of assets) and health care (19%) are well represented in COWZ through companies like Occidental Petroleum (OXY) and McKesson (MCK). COWZ gathered $2.5 billion in the first quarter.
The Invesco S&P 500 Quality ETF (SPHQ) owns 100 companies from within the S&P 500 that have strong return on equity, lower debt leverage, and high accruals ratios. The ETF pulled in approximately $750 million of new money to start 2023. SPHQ has more information technology (29% of assets) exposure than its peers, led by Apple (AAPL) and Microsoft (MSFT), but energy is a healthy 13% stake too.
With gains of 9% and 8%, respectively, QUAL and SPHQ outperformed the S&P 500 Index in the first quarter, while COWZ’s more modest 2% return lagged. This isa further reminder to advisors expecting modest equity returns in 2023 that what’s inside an equity ETF is the driver of its performance, more than its broader high-quality approach.
For more news, information, and analysis, visit the Innovative ETFs Channel.