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Three quality ETFs to adopt in turbulent markets

OWhen it comes to investment factors, market participants often discuss growth and value, but there are more chapters in the factors book. Quality is part of this conversation.

Quality often doesn’t attract the attention of growth, value, and other factors, but its long-term track record is undoubtedly impressive. One of the issues that confuses quality in terms of notoriety is that its definition is fluid with respect to growth, low volatility, size and value. While different index providers and academics have different definitions of quality, the attributes of quality stocks are universally appealing.

These include stable management teams, fortress-like balance sheets, a commitment to shareholder rewards (buyouts and dividends), and high credit ratings, among other favorable characteristics. Also, quality stocks are very relevant today.

“As the Federal Reserve nears an interest rate hike, investors are reassessing their bets on one of the riskiest corners of the market: stocks of companies that aren’t making money,” reports the Wall Street Journal. “Cash-burning tech companies, biotech companies without any approved drugs, and startups that quickly listed via mergers with blank check companies – some of which soared during the pandemic – have strongly fall.”

Keeping in mind that interpretations of quality are fluid, investors may want to avoid stock picking and consider the following quality ETFs.

1. Invesco S&P 500 Quality ETF (SPHQ)

The Invesco S&P 500 Quality ETF (SPHQ) tracks the S&P 500 Quality Index – the quality-based derivative of the S&P 500. In the case of this ETF, quality is anchored in return on equity, the ratio regularization and the financial leverage ratio.

This is a strategy that serves investors well. Over the past three years, SPHQ has narrowly outperformed the broader market, but amid high volatility and weak equity market performance this year, the quality ETF beats the S&P 500.

“Quality factor ETFs have reset significantly from highs and have one of the most attractive composite valuation scores in our coverage,” Bank of America analysts said in a recent note. “Valuation metrics are now trading near long-term averages across the group. SPHQ is trading at a P/E of 15.6x, -0.34sd below its historical average.

2. Fidelity Quality Factor ETF (FQAL)

The Fidelity Quality Factor ETF (FQAL) uses a proprietary index methodology that presents investors with a unique interpretation of quality stocks.

FQAL’s underlying index “takes a sector-neutral approach and focuses on free cash flow margin to assess whether or not a company has high earnings quality, free cash flow stability to measure the consistency and ROI to assess profitability,” said Todd Rosenbluth of CFRA Research.

FQAL, which tracks the Fidelity US Quality Factor TR USD, owns 128 stocks, 28% of which are tech names. Healthcare and financial services stocks combine for nearly a quarter of this quality ETF’s listing.

3. iShares MSCI USA Quality Factor (QUAL) ETF

The iShares MSCI USA Quality Factor (QUAL) ETF is one of the oldest and largest quality ETFs having debuted in July 2013 and currently houses $22.12 billion in assets under management. Its price is also favorable with an annual fee of 0.15%, among the lowest in this category.

QUAL tracks the MSCI USA Sector Neutral Quality Index. As the name suggests, the benchmark is intended to be sector neutral, but some groups simply house more quality stocks than others.

More than 29% of QUAL’s holdings are in technology stocks – a sector that is typically prominent in quality ETFs. The names of healthcare and consumer discretionary combine for a quarter of the fund’s list.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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