A Quality ETF That Delivers

The quality factor has long been a favored investment factor and one that is now readily accessible by investors of all skill levels via exchange traded funds.

While different issuers of exchange-traded funds may have varying definitions for quality, hallmarks of this widely studied factor include high return on equity, consistent earnings growth, low debt, robust return on assets and, in many cases, steadily rising dividends.

Sights On SPHQ

The PowerShares S&P 500 Quality Portfolio SPHQ is an example of one of the ETFs dedicated to the quality factor. Illustrating the point that quality stocks are still in style, SPHQ has recently been making a series of record highs.

The $1.19 billion SPHQ, which came to market in late 2005, follows the S&P 500 Quality Index. That index “tracks the performance of stocks in the S&P 500 Index 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 PowerShares.

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At the sector-level, SPHQ defines quality via a combined 60 percent allocation to industrial, technology and consumer staples stocks. Seven of the ETF's top 10 holdings are members of the Dow Jones Industrial Average, including Home Depot Inc HD, Procter & Gamble Co PG and United Technologies Corporation UTX.

The Difference Between Quality And Value

SPHQ is also a case study in how the quality and value factors differ. For example, many value ETFs currently feature large combined allocations to the energy and financial services sectors. Conversely, SPHQ devotes just under 6 percent of its weight to those groups.

While some factors go in and out of style, others prove durable over the long run and can offer investors some downside protection during rough markets. Historically, quality stocks do just that. Over the past 10 years, SPHQ has outpaced the S&P 500 by about 65 basis points, according to PowerShares data.

Quality stocks can be exclusive of the volatility factor, but quality names do have a historical tendency to display favorable low volatility traits.

“Quality stocks are assessed for issuers' potential to produce strong profits, as measured by often-overlooked balance sheet measures of financial health. Quality stocks have the potential to generate lower volatility and higher risk-adjusted returns than low-quality stocks,” according to Power Shares.

Over the past three years, SPHQ has been 150 basis points less volatile than the S&P 500.