Among the individual investment factors, quality has been a solid performer this year. Just look at the iShares Edge MSCI USA Quality Factor ETF (Cboe: QUAL), which is up more than 5% year-to-date.
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.
QUAL “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.
Some market observers believe quality will remain durable in the second half of this year.
“A good defense today requires exposure to stocks with the potential to weather volatility and outrun inflation. To us, this means a focus on quality companies able to generate and grow free cash flow while maintaining healthy balance sheets,” said BlackRock in a recent note.
The QUAL Query
The $5.74 billion QUAL tracks the MSCI USA Sector Neutral Quality Index and holds 124 stocks. The ETF celebrated its fifth anniversary last week.
At the sector level, QUAL, at least first glance, looks somewhat like an S&P 500 fund as technology, healthcare and financial services are the three largest sector weights. Those sectors combine for approximately 54% of QUAL’s weight.
“We find many such companies in the U.S., where earnings growth fueled by the tax overhaul offers an edge,” said BlackRock. “Companies able—and willing—to increase dividends appear better poised to withstand volatility. We see a tougher go for highly bid “stable” dividend stocks as higher U.S. rates make “risk-free” shorter-term bonds attractive alternatives.”
Speaking of volatility, QUAL’s three-year standard deviation of 9.58% is 50 basis points below the comparable metric on the S&P 500. Investors have added $1.16 billion in new assets to QUAL this year.
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