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5 High Quality ETFs for an Uncertain Market

Neena Mishra

The Federal Reserve decided to keep interest rates unchanged last week and reminded investors that the US economy remains vulnerable to “external factors”, including turmoil in China and other emerging markets. They had been priming the market for a rate hike this year as the economy recovered and the labor market tightened and thus after their decision to hold off, the outlook for monetary policy has become more uncertain.

Rates may stay near zero for much longer than expected before the FOMC meeting; in fact many now expect the Fed to wait until 2016.  Considering China’s malaise and crisis management skills of the authorities there, it is very unlikely that the world’s second largest economy and many other emerging economies will return to stability soon.  (Read: 5 ETFs to Buy and Hold for the Next % Years)

Ultimately, low interest rates are good for stocks, particularly when the domestic economy continues to perk up slowly but steadily. Given increasingly uncertain outlook for growth in other parts of the world, US stocks still remain a relatively safe bet for investors.

Focus on High Quality US Stocks 

Investors should remember that easy money in stocks has already been made and broader market returns will be lackluster in the coming months. Markets are also likely to see greater volatility going forward and it would thus be better to focus on fundamentals and invest in “high quality” stocks.



An easy way of investing in such stocks is via ETFs that focus on such “high quality” stocks. Such stocks usually have an excellent earnings record and strong balance sheets.  These stocks hold up rather well during market swings. Further, valuations on many of them look much more reasonable now after the recent sell-off and thus now may be a good time to invest in them for better risk adjustment performance over the long term. (Read: Which Low Volatility ETFs will Protect Your Portfolio?)

Qualify Factor in Academic Research

Many academic studies have demonstrated that high quality companies—as determined by factors such as high earnings quality and low leverage-- consistently deliver better risk adjusted returns than the broader market over the long term.

A recent paper “Quality Minus Junk” studied quality stocks--defined as those with high profits, high growth, low risk, and high payouts, and found that these stocks yield above-average risk-adjusted returns. The study was based on a broad sample of stocks covering 24 developed countries between 1986 and 2012.

Below we have highlighted 5 “High-Quality” ETFs that investors could consider.

iShares MSCI USA Quality Factor ETF (QUAL)

QUAL holds high quality large and mid cap US stocks indentified through three main fundamental variables: high return on equity (ROE), stable year-over-year earnings growth and low financial leverage. It charges a low expense ratio of 15 basis points per year (Read: 4 Multi-Asset ETFs to Lower Portfolio Risk)

The product holds 125 securities in its portfolio with J&J (4.6%), Microsoft (4.6%) and Apple (4.4%), being the top three holdings.

PowerShares S&P 500 High Quality Portfolio (SPHQ)

SPHQ tracks the S&P 500 High Quality Rankings Index which is comprised of S&P 500 stocks with highest “Quality Rankings”. Quality rankings are based on long-term growth and stability of a company’s earnings and dividends, using records of the most recent 10 years.
 
This product is slightly more expensive than the iShares product with an expense ratio of 29 basis points. The index uses a modified market cap-weighting scheme with the top holding accounting for just 1.4% of the asset base.

FlexShares Quality Dividend Index Fund (QDF)

The ETF uses a proprietary model that includes factors like profitability, management efficiency and cash flow. Firms are selected for inclusion in the index based on expected dividend payments and long-term capital growth potential.

Wells Fargo (3.6%), Home Depot (3.3%) and Apple (3.1%) are the top holdings. It charges an annual fee of 37 basis points.

Barron’s 400 ETF (BFOR - ETF report)

As the name suggests, BFOR tracks the performance of the Barron’s 400 Index that looks to select high performing U.S. stocks based on four fundamental factors--growth, valuation, profitability and cash flow.  

Stocks selected on the basis of strong fundamentals are then screened for certain criteria regarding concentration, market capitalization and liquidity and eligible stocks are equally weighted in the index that is rebalanced semiannually. The fund charges operating fees of 65 basis points.

SPDR MSCI USA Quality Mix ETF (QUS)

This fund holds stocks that have a combination of value, low volatility and quality factor strategies. The product has a large portfolio of 620 stocks, with Exxon Mobil (3.0%), Apple (2.5%) and JNJ (2.4%) being the top three holdings.

This new entrant in the space charges a low fee of 15 bps per year. While the concept and low expenses are its main attractions, the fund is yet to gain investor interest. Investors may like to wait before investing in this product, in view of low AUM and high trading costs as of now.
 
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