2023-06-23 07:42:09 ET
Summary
- Quality stocks, such as QUAL and JQUA, are outperforming due to their strong balance sheets and low default risk, making them valuable in a slowing economy.
- Both QUAL and JQUA have high exposure to the technology sector, contributing to their good performance.
- In a bull market, QUAL may continue to be the best-performing quality ETF, while JQUA may outperform QUAL if the economy faces more difficulties.
Quality stocks have strong balance sheets and hence low default risk. When the economy slows down, this is a valuable feature. Quality tends to outperform when the Fed ends hiking rates and when the economy is slowing down or is in recession. We don't know if we are already in a recession or not, but the Fed is certainly slowing down the economy with its rate hikes.
Anyhow, quality stocks are currently outperforming. Our two favourite quality stocks ETFs are QUAL and JQUA. The former is somewhat more aggressive, while the latter is more defensive.
Equity Factor Performance
10 year US treasury yields peaked in October of last year at 4.25%. Since then yields fell back to the current level around 3.75%. As a result, and also fuelled by the AI-boom, Growth became the best performing equity factor. Those "long duration" growth equities were no longer negatively impacted by rising rates.
Quality is also performing very well. They invest quite heavily in Technology which is very helpful of course. The iShares MSCI USA Quality Factor ETF ( QUAL ) doesn't indeed take any sector bets compared to the S&P 500. As a result, the weight of technology growth stocks is almost 30%, which contributes to the good performance of quality stocks.
Both Growth and Quality, together with Equal Weight, are in the strongest long term uptrend.
Why it's a good idea to invest in quality stocks in general and QUAL in particular, you can read here .
Today we take a look at other quality stocks ETFs.
Quality Stocks ETFs
The iShares MSCI USA Quality Factor ETF is the best performing quality ETF. Two other ETFs are also outperforming the S&P 500 Index: the Invesco S&P 500 Quality ETF ( SPHQ ) and the JPMorgan U.S. Quality Factor ETF ( JQUA ). The Vanguard U.S. Quality Factor ETF ( VFQY ) and Fidelity Quality Factor ETF ( FQAL ) are trailing the S&P 500 Index.
Given the nice performance, it comes as no surprise that all quality ETFs are in a long-term uptrend.
Figure 4: Trends (Author)
Since the end of 2021, JQUA is the best performing quality ETF.
If we split this period in a (rising rates) bear market part and a (falling rates) bull market part, we see that JQUA is the top performer in the first period, while QUAL is the worst performer.
In the second period, QUAL is the top performer before SPHQ and JQUA.
Please note that only SPHQ and JQUA are outperforming the S&P 500 in both periods.
Let's take a deeper look at the performance of the best performing quality ETF (QUAL, JQUA and SPHQ). JQUA is the youngest ETF of the three and was launched at the end of 2017. In the period since the end of 2017, JQUA is the ETF with the highest return.
At the same time JQUA is less risky. JQUA has a lower beta than QUAL, which helps explain why JQUA performed better in the bear market period, while QUAL is performing better in the bull market.
JQUA has the lowest standard deviation. So, it will not come as a surprise that it has the best risk-adjusted return with a Sharpe ratio of 0.60. Let's now take a closer look at JQUA.
JPMorgan U.S. Quality Factor ETF
JQUA tracks the JP Morgan US Quality Factor Index. This index utilizes a rules-based approach that matches Russell 1000 sector weights and targets equity securities with higher quality characteristics relative to their sector peers as measured by profitability, earnings quality and solvency/financial risk. These characteristics are combined into a quality factor, which determines which securities will be included in the index and their weights.
In comparison with QUAL, JQUA has a bigger exposure to the Financials sector, while QUAL has a bigger allocation to the technology sector.
Nevertheless, the biggest sector is also Technology for JQUA.
Figure 10: Sector allocation (JP Morgan)
And the biggest positions in JQUA are technology stocks.
Figure 11: Top 10 Holdings (JP Morgan)
Quality has its price. JQUA isn't cheap, but certainly not extremely expensive compared to the market in general.
Figure 12: Portfolio characteristics (JP Morgan)
JQUA has an expense ratio of 0.12% which is slightly less than QUAL's 0.15%. The dividend yield is 1.38% which is slightly more than QUAL's 1.32%.
Conclusion
Our favourite quality ETFs are QUAL and JQUA. Thanks to a high Technology exposure QUAL is performing well. If we remain in bull market mode QUAL might stay the best performing quality ETF.
Quality stocks normally perform well, when things get more difficult. Quality stocks have strong balance sheets and hence low default risk. When the economy slows down this is a valuable feature. In such an economic backdrop the FED normally stops hiking rates and in such a rate environment quality stocks have historically outperformed. When things get indeed more difficult, it wouldn't surprise us JQUA outperforms QUAL. We have a buy rating for both ETFs.
For further details see:
JQUA: A Good Alternative To QUAL