2023-09-01 22:58:52 ET
Summary
- The JPMorgan U.S. Quality Factor ETF has a Gold Star rating and focuses on high-quality and profitable companies. It is a simple low-cost that has mass appeal.
- However, JQUA's focus on quality without consideration for valuation may cause it to buy overvalued companies.
- Furthermore, the Quality factor may go through long stretches of underperformance.
- Overall, I believe MOAT and OMFL are better designed funds.
The JPMorgan U.S. Quality Factor ETF ( JQUA ) is a highly regarded fund that has garnered an impressive Gold Star rating by Morningstar (Figure 1).
I decided to dig a little deeper into the JQUA ETF's strategy and performance and compare it against my two favourite equity strategies, the VanEck Morningstar Wide Moat ETF ( MOAT ) and the Invesco Russell 1000 Dynamic Multifactor ETF ( OMFL ).
Fund Overview
The JPMorgan U.S. Quality Factor ETF provides exposure to companies with high quality and profitability characteristics. The JQUA ETF tracks the JP Morgan US Quality Factor Index ("Index"), an index designed to measure the returns of 'high quality' companies, as measured by their profitability, quality of earnings, and solvency.
The JQUA ETF has $2.0 billion in assets and charges a low 0.12% expense ratio.
Portfolio Holdings
The JQUA ETF is a fairly diversified with 261 holdings. The top 10 positions currently account for 19.7% of the fund (Figure 2).
Figure 3 shows the JQUA ETF's sector allocation. The largest sector weights are Technology (31.2%), Consumer Discretionary (14.3%), Health Care (12.7%), Industrials (12.7%), and Energy (4.3%).
JQUA's sector weights are designed to match that of the Russell 1000 Index, which is modeled by the iShares Russell 1000 ETF ( IWB ) shown in Figure 4.
Relative to the IWB ETF, the JQUA ETF is notably overweight Technology (31.2% vs. 27.0%) and Consumer Discretionary (14.3% vs. 10.9%). It is underweight Communications (2.3% vs. 8.4%).
Returns
The JQUA ETF has performed well, with 3 and 5Yr average annual returns of 12.2% and 11.7% respectively to August 31, 2023 (Figure 5).
This has outperformed JQUA's benchmark, the Russell 1000 Index, as measured by the IWB ETF, which has only returned 9.8% and 10.6% in the same time frames (Figure 6).
Distribution & Yield
The JQUA ETF pays a modest distribution yield of $0.58 / share or 1.3% yield, roughly equivalent to the IWB's 1.4% (Figure 7).
JQUA vs. MOAT & OMFL
How does the JQUA ETF compare against my two favourite fundamentally driven funds, the VanEck Morningstar Wide Moat ETF ("MOAT") and the Invesco Russell 1000 Dynamic Multi-factor ETF ("OMFL")?
First, on the funds' structure, the JQUA ETF has the lowest expense ratio out of the 3 (Figure 8). While returns can be volatile, fees are fixed, so JQUA outperforms with its rock-bottom expense ratio.
All 3 funds are sufficiently large such that liquidity should not be an issue for most investors.
However, in terms of returns, both MOAT and OMFL have outperformed JQUA. The MOAT ETF has delivered 3 and 5 Year average annual returns of 13.7% and 13.2% respectively to August 31, 2023 (Figure 9).
Meanwhile, the OMFL ETF has delivered 3 and 5 Year average annual returns of 16.7% and 13.2% respectively (Figure 10).
Why has the JQUA ETF underperformed the two peer funds?
First, let's consider the MOAT ETF. The MOAT ETF's strategy is to buy high quality companies that has wide Economic Moats (i.e. high quality companies), as determined by Morningstar's team of over 100 equity analysts. However, instead of blindly buying the highest quality companies, the MOAT ETF also considers the price being paid for those companies.
Hence when high quality companies become 'expensive' relative to the analysts' estimate of fair value, the MOAT ETF will trim or eliminate the position altogether. For example, the largest holding in the MOAT ETF in early March was Meta Platforms Inc. ( META ), the company behind popular social media apps like Facebook, Instagram, WhatsApp, and now Threads, at 3.3% of the portfolio (Figure 11).
However, as META has rallied significantly in the past few months, the MOAT ETF's weight in META has now been reduced to only 1.7% (Figure 12).
The MOAT ETF also does not hold positions in stocks that are trading grossly above Morningstar analysts' estimate of fair value like Apple Inc. ( AAPL ), even if the company is considered to have a wide economic moat (Figure 13).
In my opinion, MOAT's focus on high quality companies and the valuations paid for these companies, has allowed the MOAT ETF to outperform the JQUA ETF.
I last wrote about the MOAT ETF here .
Moving on to the OMFL ETF. The OMFL ETF dynamically adjust its factor weights depending on management's judgment of the current phase of the economic cycle. During Recovery and Expansion phases, the OMFL ETF is more aggressive and over weights factors like Value and Momentum . During Slowdown and Contraction phases, the OMFL ETF is more defensive and over weights Quality and Low Volatility (Figure 14).
The reason a multi-factor fund like OMFL outperforms a single-factor fund like JQUA is because different factors exhibit active return patterns that ebb and flow over time (Figure 15).
While the Quality factor may outperform in the long-run, it can also go through long stretches where it underperforms the market, as other factors gain prominence. For example, coming out of the 2015/16 global growth slowdown scare, the Quality factor underperformed for multiple years as investors chose to chase Momentum and Value.
OMFL is able to dynamically allocate to different factors depending on the business cycle, allowing it to outperform JQUA's singular focus on the Quality factor.
I last wrote about the OMFL ETF here .
Conclusion
Overall, the JPMorgan U.S. Quality Factor ETF is a low-cost ETF that focuses on the Quality factor and has delivered returns superior to its benchmark, the Russell 1000 Index.
However, I see two potential issues with the JQUA ETF that cause it to underperform my two favourite fundamental ETFs, the MOAT and the OMFL. First, the JQUA ETF only focuses on high quality companies without consideration for valuations. This may cause the JQUA ETF to buy overvalued high quality companies and underperform the MOAT ETF, which considers both quality and valuations paid.
Second, the JQUA ETF is a single factor strategy that only focuses on the Quality factor. Although Quality has been proven to outperform in the long-run, it can also underperform the market for long periods of time. Therefore, a dynamic multi-factor fund like the OMFL that has Quality as one of its many tools may outperform JQUA over the long-run.
While I like JQUA's performance, I am sticking with MOAT and OMFL for my core equity allocation. I rate JQUA a hold .
For further details see:
JQUA: I Like MOAT And OMFL More