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'High-Quality' ETFs for Long-term Outperformance

Neena Mishra

The stock market has had an incredible run this year as the massive surge of cheap money lifted all stocks, even in the face of modest economic growth and lackluster earnings. (Read: 4 Unbeatable Startegies for Q4)

The market expects that under Janet Yellen’s leadership, the Fed may start tapering later than earlier expected.  Further, the political drama in Washington may prevent the Fed from scaling back the stimulus this year. But tapering has to start eventually and once the QE begins to fade away, investors will turn their focus to fundamental and only the “better” stocks will shine.

One way to discover better stocks is to look at “quality”. Academic research shows 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 long term.

An easier solution is provided by some of the ETFs that focus on such “high-quality” stocks. Such stocks usually have anexcellent earnings record and strong balance sheets. (Read: 3 Niche ETFs crushing the market)

iShares MSCI US Quality Factor ETF (QUAL)

QUAL tracks the MSCI USA Index, which is comprised of high quality stocks, by identifying stocks with high quality scores based on 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. (Read: 3 Ultra Cheap ETFs for Value Investors)

The product holds 124 securities in its portfolio with Apple (5.6%), Microsoft (4.9%) and Google (4.9%) being the top three holdings. In terms of sectors, Technology takes about 40% of the asset base, while Consumer Discretionary, Energy, and Healthcare also get double digit allocations.

The fund has a SEC yield of 1.62%.Launched in July this year, the fund has already attracted an impressive $148 million in assets so far.

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 Quality Rankings of A- and above. Quality rankings are based on long-term growth and stability of a company’s earnings and dividends across the most recent 10 years.
This ETF was earlier known as PIV and was tracking the Value Line Timeliness prior to the launch of S&P High Quality Rankings Index. From June 2010 it starts tracking the new index.
This product is slightly more expensive than the iShares product with an expense ratio of 29 basis points. It currently sports a dividend yield of 1.8%.

The product holds 130 securities in its basket but is very well diversified with the top holding Nike accounting for just 1.4% of assets. Industrials have the highest weight at 26%, with Consumer Discretionary and Consumer Staples rounding out the top three.

How have they performed?





S&P 500

S&P 500 High Quality Rankings Index

MSCI USA Standard Index

MSCI USA Quality Standard Index

Annualized Return





Annualized SD





Since these ETFs are relatively new (QUAL launched this year and though SPHQ was launched earlier, it was tracking another index until June 2010), we looked at the performance of the indexes that these ETFs are tracking. We used the five-year performance history (total return) of the indexes MSCI USA Quality Index and S&P 500 High Quality Rankings Index with their respective broader market indexes S&P 500 Index and MSCI USA Index.

Both these ETFs have delivered better returns than the broader market, with lower or same volatility.

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Read the analyst report on SPHQ

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