The quality factor is getting plenty of attention this year, shedding new light on some of the related ETFs in the process. One of the hidden gems of the quality ETF group is the FlexShares US Quality Large Cap Index Fund (NasdaqGM: QLC).
QLC selects and weights companies based on management efficiency, profitability, and cash flow to determine quality, according to FlexShares. Management efficiency is a quantitative evaluation of a firm’s deployment of capital and its financing decision. Profitability scores help weed out firms with wider margins, which may be better positioned to grow. Lastly, cash flow signals the liquidity level of a company. Those with higher cash flows may be better situated to take advantage of potential opportunities or enjoy a financial cushion in downturns.
With the current bull market in U.S. equities and the business cycle aging, the time could be appropriate for investors to consider factor strategies beyond growth and value.
Quality should not be conflated with low volatility, but there are times when quality stocks display low volatility traits. That was the case during the October market swoon, indicating that the quality factor can provide some protection during times of elevated market stress.
The QLC Query
“The quality factor originally was designed as a tool to gain confidence in the financial strength of dividend-paying equities, but investors have steadily evolved how they use it in their portfolios,” said FlexShares. “Instead of looking at dividend-paying equities as a means to meet income needs, quality dividend payers can also be looked at as a means to grow assets through their core investments.”
QLC, which is nearly four years old, holds 141 stocks, over a quarter of which hail from the technology sector. The healthcare and financial services sectors combine for 26% of QLC’s roster.
Related: A Quality Factor ETF Up 19% YTD
In the early stages of bull markets, lower-quality companies see their shares soar. However, as the bull matures, investors often exhibit a preference for higher quality fare with more compelling valuations.
QLC skirts value traps by including momentum characteristics, which will be determined through a stock’s price history to capture a picture of the recent performance and by using analysts analyst outlooks to get a sense of future sentiment regarding a company. While QLC emphasizes quality, it actually is a multi-factor fund, a strategy that can prove useful for investors looking for the benefits of other factors beyond quality.
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