Smart Beta Investing: Right Time to Confirm Quality

Quality stocks are working this year. Confirmation of that notion comes by way of the iShares Edge MSCI USA Quality Factor ETF (BATS: QUAL), which is up 15% year-to-date and currently residing near record highs.

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.

“To be fair, quality is harder to define. Generally, when investors talk about quality, they are referring to large, stable companies with at least three common characteristics: high return-on-equity, earnings consistency and low debt,” according to BlackRock. “There are two arguments in favor of adding quality to a portfolio—either directly through a stock screen or an exchanged traded fund (ETF). First, there is a strategic argument. Looking at style factors within a broader multi-asset portfolio, quality generally receives a high allocation.”

The $3.9 billion QUAL tracks the MSCI USA Sector Neutral Quality Index. QUAL allocates 24% of its weight to technology stocks and a combined 29.3% of its roster to the financial services and healthcare sectors.

“Quality companies tend to be stable, and by extension their stocks less volatile. For example, the one-year volatility (in other words, how much the stocks’ prices fluctuate relative to history) of the MSCI U.S. Sector Neutral Quality Index is roughly 20% lower than for either the respective MSCI value or growth indexes (source: Bloomberg, as of 10/18/17),” notes BlackRock.