The quality factor is the spotlight this year and that is proving to be good news for exchange traded funds, such as the iShares Edge MSCI USA Quality Factor ETF (Cboe: QUAL).
QUAL seeks to track the investment results of the MSCI USA Sector Neutral Quality Index composed of U.S. large- and mid-capitalization stocks exhibiting quality characteristics as identified through racks U.S. large- and mid-capitalization stocks based on quality screens for three fundamental variables: return on equity, earnings variability and debt-to-equity.
QUAL “targets large- and mid-cap U.S. stocks with the best profitability, strongest balance sheets, and most consistent earnings growth relative to their sector peers,” said Morningstar. “This sector-relative approach to stock selection leads to cleaner comparisons, but it can also cause the fund to own stocks with lower absolute quality characteristics than it otherwise would.”
Exploring the Quality Factor
The quality factor is a point of emphasis for a growing number of strategic beta exchange traded funds. Though there has been debate surrounding defining quality as it pertains to factor-based investing, quality companies and dividend-paying stocks often go hand-in-hand because those dividends are seen as signs of stable earnings and thoughtful management.
QUAL, which follows the MSCI USA Sector Neutral Quality Index, holds 125 stocks. Over 35% of the ETF’s combined weight is allocated to technology and healthcare stocks.
“Quality has historically outperformed other equity style factors in economic slowdowns, our analysis shows. One sector where we find these quality characteristics: health care. The sector also shows low sensitivity to global growth, which historically has provided resilience in late cycle,” according to BlackRock.