Make A Quality Call With This ETF

Among investment factors and the related exchange traded funds, low volatility is hogging the limelight this year. But investors should not overlook the quality factor and ETFs such as the iShares Edge MSCI USA Quality Factor ETF QUAL.

What Happened

Quality is often viewed as the most variable, hardest-to-define investment factor, but QUAL's year-to-date gain of 18.60% cannot be refuted nor can the notion that the hallmarks of quality are positives and winners over the long-term.

Those traits usually include some mix of companies with strong balance sheets, light leverage, strong management teams and commitment to returning capital to shareholders, among other traits. That said, quality isn't a guarantee of consistently strong returns.

There are times when the factor, like any other factor, lags.

“Quality tends to under-perform in sharply rising markets, such as when the economy is coming out of a recession,” said BlackRock in a recent note. “At times like these, riskier lower-quality companies with higher leverage tend to outperform as they surge from their beaten-down state.”

Why It's Important

As noted above, quality and low volatility are two different beasts, but they share some commonalities, namely reduced volatility, which likely explains some of QUAL's success this year.

“Quality stocks may forfeit some incremental return in big market bounces, but history suggests they also are likely to lose less in the inevitable falls,” according to BlackRock. “This, on a net basis, makes them better investments over the course of a full cycle, we believe.”

Like rival low volatility strategies, QUAL is sector agnostic and unlike reduced volatility funds, it is not significantly overweight a specific sector or sectors.

The quality fund allocates 23.23% of its weight to technology stocks, or just 120 basis points more to that sector than is found in the S&P 500. QUAL's healthcare and financial services exposures are mostly inline with the benchmark domestic equity gauge.

What Happened

Methodology aside, what some investors may be focusing on is factor timing, which is often a fool's errand, but right now, it's clear quality is working.

“Quality stocks particularly stand out today,” according to BlackRock.

“The fact that we are late cycle and markets are being rocked by U.S.-China trade noise and the vagaries of an election cycle tells me we may be in for a continued period of heightened volatility. A focus on quality stocks can allow investors to stay in the market to benefit from potential upturns, but with a measure of prudence built in to buffer downturns.”

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