Quality Factor Continues Looking Alluring in Rough Environment

Amid heightened concerns about corporate credit ratings, balance sheets, dividend sustainability, and other issues, the quality factor reminds investors there are ways to focus on sturdy companies, an objective accomplished by the Invesco S&P 500 Quality ETF (NYSEArca: SPHQ).

SPHQ seeks to track the investment results of the S&P 500 Quality Index. In selecting constituent securities for the underlying index, the index provider calculates the quality score of each security in the S&P 500 Index, then selects the 100 stocks with the highest quality score for inclusion in the underlying index.

There’s something to the quality factor as highlighted by SPHQ’s year-to-date outperformance of the S&P 500 of 270 basis points.

Quality has historically outperformed other investment factors during economic slowdowns, but that thesis could be challenged if quality ETFs amass large positions in cyclical sectors, such as tech.

SPHQ Struts Its Stuff

Historical data confirm that the quality factor wins over the long-term as the most profitable companies have easily outpaced their less profitable peers by significant margins over longer holding periods. SPHQ’s benefits are on display this year.

“In Q1 2020, single factors including momentum, quality, and low volatility were able to outperform the S&P 500 Index. The dispersion in factor performance was remarkable and more than twice that of Q4 2019,” explained Nick Kalivas, Senior Equity ETF Strategist at Invesco, in remarks to ETF Trends. “Investors sought out companies that were large and/or had healthy balance sheets to weather the economic dislocation created by COVID-19 and OPEC+.”

Valuing high quality value is particularly important as bull markets enter their waning stages, as some market observers believe the current bull market is doing. 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.

With the economy and equity markets still beholden to the coronavirus, the quality factor and SPHQ could take on added importance in the second quarter.

“While it is nearly impossible to provide a clear outlook for Q2 2020, quality is a factor that has the potential to remain appealing,” said Kalivas. “Low debt, cash earnings, and high return on equity may provide comfort to investors in difficult economic conditions while offering the potential to participate meaningfully in a post Virus economic recovery.”

For more on multi-factor strategies, visit our Multi-Factor Channel.

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.