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5 Quality ETFs to Help Smooth Out a Volatile Ride

This article was originally published on ETFTrends.com.

After years of sitting back and enjoying the ramp up in growth, investors are now getting a taste of the increased volatility that usually occurs towards the end of a bullish cycle. As many reevaluate their investment portfolios, one may consider quality exchange traded fund strategies to help smooth out the ride ahead.

Looking at the slope of the yield curve, Bank of America Merrill Lynch argued that volatility could double in 2019 and believed that many investors, notably the millennials demographic, are unequipped to handle the sudden change up, CNBC reports.

"The most memorable early event of their careers was likely the Financial Crisis," Equity and Quant Strategist Savita Subramanian said in the note. "Growth and momentum stocks have outperformed for their entire careers, whereas value investing has been a losing proposition."

The CBOE Volatility Index, or so-called VIX, a gauge known as Wall Street's "fear index," has averaged around 17 since for this age group, or 25% lower than the prior two decades' average of 22. During the more complacent market conditions in recent years, many investors have focused on high-flying growth stocks like those found in the technology segment, but we will need to adapt to the changing conditions ahead.

"The prototypical professional investor is likely focused on growth and momentum, thinks Financials are uninvestible, is unused to volatility, and sees valuation as largely irrelevant," Subramanian said. "But momentum is now expensive, crowded and at risk, Financials are transformed and valuation always matters, eventually."

Consequently, Subramanian argued that investors should focus on "high quality companies".

As more analysts are calling for a shift to quality or companies with healthy balance sheets and strong cash flow, ETF investors can also focus on this segment of the markets for a more defensive portfolio tilt.

For example, the iShares Edge MSCI USA Quality Factor ETF (Cboe:QUAL) is one ETF focusing on quality. 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.

The Invesco S&P 500 Quality ETF (SPHQ) is one of the elder statesmen of the quality ETF category, having come to market in late 2005. The ETF’s quality tilt comes by way of emphasizing companies’ long-term earnings growth dividend-paying potential. The underlying index focuses on companies with the highest quality as determined by fundamental measures, including return on equity, accruals ratio and financial leverage ratio.

The Oppenheimer Russell 1000 Quality Factor ETF (OQAL) bets on higher quality companies in the hopes that they perform better than lower-quality companies. The fund screens for an equally-weighted composite of return on assets, change in asset turnover, accruals, and leverage, calculated based on information reported in the company’s most recent annual financial statement as of the last business day of the prior month.

The American Century STOXX U.S. Quality Value ETF (VALQ) tries to reflect the performance of the iSTOXX American Century USA Quality Value Index, which is made up of 900 largest publicly traded U.S. equity securities screened and weighted by fundamental measures of quality, value and income.

Additionally, the J.P. Morgan U.S. Quality Factor ETF (JQUA) is designed to provide exposure to high quality companies. JQUA tries to reflect the performance of the J.P. Morgan U.S. Quality Index, which is comprised of U.S. securities included in the Russell 1000 Index and selects constituents based on their quality as measured by profitability, solvency and earnings quality.

For more information on the smart beta strategy, visit our smart beta category.

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