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Look to Quality ETFs in Troubled Times

This article was originally published on ETFTrends.com.

Exchange traded funds that focus on quality companies are garnering more attention as investors look to take cover in these stormy conditions.

“We’ve seen a lot more returns to quality stocks, to value stocks, and investors looking for cover in safer areas of the market,” Paul Moghtader, a managing director on the quant team for Lazard Asset Management, told Bloomberg.

At the start of the year, investors were piling into the growth and momentum game as U.S. markets pushed higher. Over the first half of the year, growth and momentum ETFs saw the largest amount of inflows, bringing in $8 billion and $3.5 billion, respectively, according to Bloomberg Intelligence.

However, as volatility spiked and markets retreated, the growth and momentum play lost steam. Over the later half of the year, the amount into growth halved while momentum ETFs experienced net outflows. Meanwhile, value and low volatility products enjoyed the greatest demand, attracting a combined $30 billion in net inflows.

Looking ahead, analysts are almost unanimously calling for a shift to quality or companies with healthy balance sheets and strong cash flow.

“As people position into 2019, investors are getting more defensive, and defensive usually targets quality: quality of earnings, earnings sustainability, making sure you have positions that are solid in case there is more volatility,” Omar Aguilar, the chief investment officer for equities at Charles Schwab Investment Management, told Bloomberg. “The theme for factors going into next year is definitely toward defensive.”

ETF investors can also target quality companies through a targeted factor-based, smart beta strategy. 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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