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Don’t Forget to Add a Dash of Quality to Your Portfolio

This article was originally published on ETFTrends.com.

U.S. equities relished off the high of President Donald Trump and Chinese President Xi Jinping agreeing to cease fire on tariffs as both nations continue to work on an ironclad trade deal, but investors should still add a dash of quality to their portfolios when the optimism wanes.

“The markets appear to be content with the cooperative tone coming out of the meetings. To me, it felt like the contrarian play was to the upside post meetings,” said Dan Deming, managing director at KKM Financial. “There was a great deal of bearishness in sentiment headed into the meeting. Many market observers were discounting any change in the narrative, which made many believe the risk was to the downside.”

One way to add quality is via the iShares Edge MSCI USA Quality Factor ETF (QUAL) . QUAL seeks to track the investment results of the MSCI USA Sector Neutral Quality Index composed of U.S. large- and mid-capitalization stocks with quality characteristics as identified through certain fundamental metrics.

“There was a fair amount of exuberance at the open. I don’t know if it was celebrating good news or the absence of bad news,” said Willie Delwiche, investment strategist at Baird. “Either way, we started strong. The problem is, while we had a new high on the S&P 500, the number of individual stocks making new highs was shy of what we say back in late June,” when the index made its latest record close.

“I don’t want to overstress the importance of it, but it is not confirming the index-level highs,” Delwiche said.

ETF and Mutual Fund Investors Differ

Even with a December 2018 to forget, ETFs continued to amass assets to the tune of over $51 billion while mutual fund flows suffered. Mutual funds, bond and equity funds, in December lost a record $152 billion.

One would assume that outflows from U.S. equities in 2018 would also be evident in ETFs that have been purchasing the downtrodden shares in the three major indexes. However, that hasn’t been the case as ETFs received $314 billion worth of inflows despite a challenging 2018–a drop from the $466 billion the previous year, but given the challenges of 2018, an impressive figure nonetheless.

Compare that to mutual funds, which have been trailing ETFs in terms of organic growth rate, the estimated net flow over a period divided by beginning net assets, within the last 10 years according to Morningstar. In fact, the average 10-year growth rate over ETFs is 16% versus the paltry 2% for mutual funds.

The growth of ETFs is a trend that will likely persist, and one that highlights a dichotomy between ETF investors and mutual fund investors. Just as markets were getting roiled in 2018, money continued to flow into ETFs, but what is fueling this divergence?

The answer lies in the inherent benefits of ETFs compared to mutual funds–a confluence of the investment vehicle’s simplicity, liquidity, tax efficiency, a plethora of choices with over 2,000 ETF products, and much more.

With 2018's year-end sell-offs in U.S. equities, investors are giving value investing another look as growth and momentum might be making their way to the exits. A byproduct of a shift to value is a focus on the quality of investments–being selective and using due diligence as screeners to find the best-performing investments.

For more market trends, visit ETF Trends.

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