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How This Quality ETF Stacks Up

This article was originally published on ETFTrends.com.

In what is proving to be a turbulent fourth quarter for U.S. stocks, more advisors and investors are considering factor-based strategies and exchange traded funds.

The Invesco S&P 500 Quality ETF (SPHQ) , which tracks the S&P 500 Quality Index, is one of the ETFs with a direct emphasis on the quality factor. There are varying definitions of quality, “but the common traits are a sturdy business not reliant on a strong economy; high and resilient profitability; and a strong balance sheet unburdened by much debt,” according to CNBC.

While the quality factor often trades at a premium to value, quality stocks are usually less volatile than traditional broad market strategies, indicating some overlap with the low volatility factor.

“Quality, together with other defensive factors such as low volatility, has a higher degree of downside protection compared with other risk factors like value or momentum,” said S&P Dow Jones Indices in a recent note. “For example, during months in which the returns of the S&P 500 are negative, the quality factor has higher returns than the benchmark about 75% of the time.”

Inside SPHQ's Methodology

SPHQ's underlying index includes the S&P 500 stocks “that have the highest quality score, which is calculated based on three fundamental measures, return on equity, accruals ratio and financial leverage ratio,” according to Invesco.

Over the past three years, SPHQ has returned 9.28%, according to issuer data. The ETF currently holds 99 stocks with an average market capitalization of $126.33 billion.

“Market volatility has a way of making investors rethink defensive equity strategies. The S&P 500 Quality Index, with a high hit rate of 75% during down months, is a factor that has historically had a higher degree of downside protection compared with riskier factor strategies,” according to S&P Dow Jones.

Valuing high quality value is particularly important as bull markets enter their waning stages, as some market observers believe the current bull market is doing. In the early stages of bull markets, lower quality companies see their shares soar. However, as the bull matures, investors often exhibit a preference for higher quality fare with more compelling valuations.

While the quality factor can have some overlap with value, over 44% of SPHQ's large-cap holdings are classified as growth stocks.

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

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