Quantifying Quality With An iShares ETF
In the world of factor investing, the quality factor does not always grab the headlines that the growth and value factors do, but quality stocks can deliver impressive returns over the long term.
“MSCI research finds that a company’s quality can be evaluated along five key dimensions: profitability, earnings quality, financial leverage, asset growth and corporate governance,” said the index provider.
Investors looking to focus on the quality factor with exchange traded funds can consider the iShares Edge MSCI USA Quality Factor ETF (CBOE: QUAL). QUAL tracks the MSCI USA Sector Neutral Quality Index, a benchmark that focuses on stocks with return on equity, earnings variability and debt-to-equity traits.
A Growth Feel
QUAL looks for stocks displaying favorable quality traits as defined by MSCI across all sectors, so the ETF is sector-agnostic. Quality stocks can be less volatile than non-quality names, as highlighted by QUAL's three-year standard deviation of just 9.76 percent — but quality companies may also be pricey relative to traditional fare.
“These stocks often carry above-average valuations, and because the fund does not impose a valuation discipline, it tends to exhibit a growth tilt,” Morningstar said in a recent note. “The strategy's sector-relative stock selection approach leads to cleaner comparisons, but it can cause the fund to own stocks with lower absolute quality characteristics than it otherwise would.”
QUAL is home to 125 stocks, nearly one-quarter of which hail from the technology sector. Financial services and health care stocks combine for about 28 percent of the ETF's weight. QUAL's top 10 holdings include Apple Inc. (NASDAQ: AAPL), Mastercard Inc. (NYSE: MA), Johnson & Johnson (NYSE: JNJ) and BlackRock Inc. (NYSE: BLK). BlackRock is the parent company of iShares, QUAL's issuer.
'A Little Better'
“The types of stocks the fund favors have tended to hold up a little better than average in market downturns,” said Morningstar. “Their competitive advantages help protect profits and should make them slightly less sensitive to the business cycle than less-advantaged firms. For instance, during the bear market from late 2007 through early 2009, the fund's index cumulatively lost 47 percent, while the MSCI USA Index lost 54.7 percent.”
QUAL is lightly allocated to high-beta commodities sectors, such as energy and materials, as well as rate-sensitive groups, including real estate, telecommunications and utilities. The real estate, telecommunications and utilities sectors represent just 7.5 percent of QUAL's roster on a combined basis.
Morningstar has a Silver rating on QUAL.
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