In theory, there’s never a bad time to embrace quality stocks and the exchange traded funds that hold those names, but there are times when quality works well and times when it lags.
Those are the breaks with any investment factor, but in the current environment, the stars are aligning for quality, and that could be a sign that investors may want to evaluate ETFs such as the WisdomTree US Quality Dividend Growth Fund (DGRW).
DGRW is outpacing the S&P 500 by nearly 300 basis points year-to-date. Alone, that’s impressive, but there are other reasons why the current climate is conducive to quality strategies like DGRW.
“Profitability as a proxy for quality captures the outperformance of highly profitable firms that can continue to thrive in difficult economic and market conditions thanks to strong, proven business models. Such companies tend to be in demand when investors start to worry about future outcomes and when economic visibility is reduced, leading to outperformance in high-volatility and end-of-cycle periods,” says Pierre Debru, head of quantitative research and multi-asset solutions at WisdomTree Europe.
While low volatility and quality are two distinct investment factors, many novice investors view these concepts as one and the same. That’s understandable, but market participants should realize that lower quality stocks need market volatility to be low to thrive. That’s not the case for quality names.
“On the contrary, highly profitable, high-quality companies see their outperformance increase with volatility. In other words, highly profitable companies tend to act as a safe haven for investors in periods of stress and high volatility, leading to the highest outperformance in those periods,” adds Debru.
That said, DGRW has some avenues for reducing volatility, as highlighted by a 38% combined weight to consumer staples and healthcare stocks. Those sectors don’t just offer reduced volatility. They also offer reliable sources of quality payout growth.
DGRW is also relevant today because many companies with the quality label have pricing power — a trait that investors should consider in inflationary times.
“Looking at the WisdomTree U.S. Quality Dividend Growth Index, we find Apple, Microsoft, Coca Cola and Pepsico in the top 15. Coca-Cola and PepsiCo raised prices within days of each other last July and have recorded substantial margins since then,” concludes Debru.
Apple (NASDAQ:APPL) is DGRW’s largest holding, while Microsoft (NASDAQ:MSFT) is in the third spot. The aforementioned quartet of stocks combines for about 15.5% of DGRW’s weight.
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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.
