Quality Impresses, But It's Not Cheap | ETF Trends

As investors have prioritized profitable, financially sound companies in the 2019, the quality factor and the related ETFs have received renewed attention. For instance, the iShares Edge MSCI USA Quality Factor ETF (CBOE: QUAL) is higher by almost 28% this year.

QUAL seeks to track the investment results of the MSCI USA Sector Neutral Quality Index composed of U.S. large- and mid-capitalization stocks with quality characteristics as identified through certain fundamental metrics. Quality isn’t low volatility, but the former does have a way of reducing portfolios volatility during turbulent times.

While quality is clearly on a roll this year, the factor and its benefits are getting expensive to indulge.

“The dash to quality has never really been about valuation. Rather, investors have been worried about an economic slowdown,” reports Evie Liu for Barron’s. “Since quality companies generally hold up better during a downturn, their stocks have become very popular. Whether you like them depends on where you think we are in the economic cycle.”

Tilting The Fund Allocation

QUAL follows the MSCI USA Sector Neutral Quality Index and holds 125 stocks. Nearly 26% of the fund’s weight is allocated to the healthcare and financial services sectors, groups that are considered value plays.

“When economic growth starts to slow, investors prefer safer stocks to riskier ones. That’s one reason we’re seeing so-called high-quality stocks outperform in 2019, a year in which recession fears have run rampant at times,” according to Barron’s.

Looking ahead, analysts are almost unanimously calling for a shift to quality or companies with healthy balance sheets and strong cash flow.

Related: Fend Off Junk Bond Jitters With This ETF 

“The typical economic downturn lasts an average of eight months, according to Bank of America Merrill Lynch’s U.S. Regime Indicator. According to the bank’s calculations, that’s where we are now,” according to Barron’s.

However, while a recession may not be imminent, global growth is likely to slow, potentially driving more investors to funds like QUAL. Additionally, some market observers believe that the current economic environment will likely be persistent for some time, possibly compelling investors to embrace quality even if the valuations are rich.

Investors have added nearly $5 billion to QUAL this year.

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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.