The quality factor is an important part of the investment lexicon and one that is accessible via exchange traded funds, including the iShares Edge MSCI USA Quality Factor ETF (Cboe: QUAL).
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.
“While there is no single definition, quality typically connotes some combination of high profitability, low debt-to-equity and earnings consistency,” said BlackRock in a note out Wednesday. “In aggregate, this style offers two potential advantages. First, quality has historically delivered a return premium, i.e. the opportunity to outperform a broad benchmark over the long term. Since 1990, the MSCI Quality Index has beaten the S&P 500 by approximately 0.10% per month on average.”
QUAL, which is nearly five years old, “seeks to track the investment results of an index that measures the performance of U.S. large- and mid-capitalization stocks as identified through three fundamental variables: return on equity, earnings variability and debt-to-equity,” according to iShares.
The $4.38 billion ETF follows the MSCI USA Sector Neutral Quality Index and holds 125 stocks. QUAL allocates over 40% of its combined weight to the technology and financial services sectors. The ETF is up more than 2% year-to-date.
“Quality tends to perform best when other styles, and the broader market, are struggling,” said BlackRock. “Quality typically outperforms momentum during periods of turbulence. During the most recent pullback, quality once again outperformed, albeit by a relatively small margin. Most likely, part of the reason quality did not offer more protection was the nature of the selling.”
Quality stocks can also be less volatile than the broader market. For example, QUAL’s three-year standard deviation of 9.76% is slightly below that of the S&P 500.
“Over the long term quality has proved its worth, particularly during periods characterized by rising volatility. Since 1990, in months when the VIX rose by 20% or more, quality beat the S&P 500 by an average of approximately 60 basis points (bps, or .60%),” according to BlackRock.
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