Calling On Quality In Volatile Times

Stocks with the quality designation are, broadly speaking, less volatile than their lower quality peers, dividend payers and raisers and prolific cash generators. Usually, quality stocks are less bad during volatile markets and that trait explains why the iShares MSCI USA Quality Factor ETF (iShares Trust QUAL) is down 1.8 percent this year compared to a 2.2 percent loss for the S&P 500.

QUAL tracks the MSCI USA Sector Neutral Quality Index. That “index aims to capture the performance of securities that exhibit stronger quality characteristics relative to their peers within the same GICS sector by identifying stocks with high quality scores based on three main fundamental variables: high Return-on-Equity (ROE), low leverage and low earnings variability,” according to MSCI.

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On the surface, it might appear as though QUAL meets the definition of a broad U.S. equity ETF, but with quality as a qualifier, the $2 billion ETF is home to just 123 stocks. Perhaps it is fair to say quality is an exclusive, but potent club.

“When we say 'high quality' companies, we are referring to companies characterized by high profitability, steady earnings, and low leverage. This may seem obvious, but we are looking for financially healthy companies that can weather the markets and volatility,” said BlackRock Global Investment Strategist Heidi Richardson in a note.

Holdings And Allocations

Other marks of high quality companies are strong balance sheets and an ability to consistently generate cash. So it is not surprising that over 20 percent of the ETF's weight is allocated to technology stocks, its largest sector weight. Microsoft Corporation MSFT and Apple Inc. AAPL combine for nearly 8 percent of QUAL's weight.

With earnings consistency and visibility along with lower volatility being integral elements to the quality factor, it is not surprising that energy and materials names represent less than 10 percent of QUAL's lineup.

“Additionally, exposure to companies that have the potential to sustainably increase dividends over time may be an opportunity to target steady growth – as well as income that can help provide some buffer from volatility,” added Richardson.

QUAL charges just 0.15 percent per year, or $15 for every $10,000 invested. That is low among strategic beta ETFs.