Summary
- SPHQ is an ETF that screens the S&P 500 for the 100 stocks that best meet a strict set of requirements it calls a "quality score."
- SPHQ is one of my favorite large-cap ETFs because of the rigorous quantitative process it uses to find quality stocks within the broader S&P 500.
- SPHQ gets a buy rating from me. It's a solid choice as a core equity ETF for intermediate- to long-term investment purposes.
By Sweta Shah
The Invesco S&P 500 Quality ETF ( SPHQ ) is one of my favorite core equity ETFs. Its portfolio is the result of a consistently applied, rigorous quality rating system. This produces a 100-stock portfolio that includes exposure to all 11 GICS sectors. There's a lot to like about an ETF that goes to the lengths that SPHQ does to identify a limited number of high-quality stocks from within the market's most popular benchmark index, the S&P 500. I rate SPHQ a buy based on an intermediate- to long-term outlook.
Strategy
SPHQ is based on the S&P 500 Quality Index, a very specific benchmark that uses a detailed methodology to select stocks from within the S&P 500. The fund is passively managed and is rebalanced and reconstituted semiannually. In other words, every six months the manager calculates what they refer to as a "quality score" for each stock in the S&P 500. That process concludes with the updated component stocks that make up the index for the next six months (on the third Friday of June and December each year).
That quality score is determined by analyzing each stock's return on equity (based on trailing 12-month earnings divided by the latest book value per share), accruals ratio (net operating assets over the last year, divided by average total assets over the last two years), and financial leverage ratio (the company's latest total debt divided by the company's book value). This produces a 100-stock portfolio, weighted according to the following formula: (quality score) x (market capitalization). Finally, there is a set of security and sector constraints and optimization procedures used to finalize the index for each rebalancing event. The fund must hold at least some exposure to each of the 11 GICS sectors, though no individual sector can account for 40% of SPHQ's portfolio as of each rebalancing date.
Holdings in SPHQ have a minimum weight of 0.05%, and a maximum weight that is the lesser of 5% or 20x that stocks' market capitalization in the S&P 500. For instance, if a stock is a mere 0.1% of the S&P 500 index, it cannot be brought into this index at a weighting of more than 2.0%.
ETF Grades
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Offense/Defense: Offense
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Segment: Broad Equity
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Sub-Segment: S&P 500 Subset
Technical Ratings
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Short-Term (next three months): B
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Long-Term (next 12 months): B
Rating scale: A = Excellent, B = Good, C = Fair, D = Weak, F = Poor. For a detailed description of MII's proprietary technical rating system, see disclosures at bottom of this report.
Holding Analysis
SPHQ's highly detailed portfolio construction process currently leaves the ETF with a sector and top holdings picture that looks like this:
Allocation by sector (Seeking Alpha) Top 10 holdings (Seeking Alpha)
Like the S&P 500 itself, SPHQ's highest-weighted sector is currently technology. More significant to me is the notable overweighting of energy, which is more than 13% of SPHQ but only 5% of the S&P 500, following that sector's strong performance in 2022. Consumer cyclical stocks, which are about 10% of the S&P 500, only take up 3.5% of SPHQ.
The quality formula and portfolio structure used to create and manage SPHQ is currently favoring sectors that are particularly sensitive to economic recessions. Those four sectors (communications, energy, industrials, and technology), collectively referred to as the Sensitive Super Sector, account for about 55% of SPHQ. That is a nearly 10% higher weighting in those sectors vs. the S&P 500.
Strengths
SPHQ is quite possibly one of the most intelligently constructed ETFs devoted to the U.S. equity market. It screens out lower-quality stocks. And even though the S&P 500 is thought of as being made up of the prime companies in the U.S. stock market, over time company fortunes can rise and fall, but the stock can remain in the index for some time. Thus, filtering out the highest 100 by this quality measure helps to keep the worst-positioned companies out of this ETF's portfolio.
SPHQ is abundantly liquid, with more than $4 billion in assets and a typical day's trading volume in excess of $40 million. Furthermore, SPHQ provides exposure to a broad range of companies, yet focuses on the upper end of the 100-stock portfolio. The top 25 holdings make up more than 70% of SPHQ, so investors can look at this ETF as predominantly a 25-stock portfolio. The remaining 30% of assets have a significantly smaller impact on performance.
Weaknesses
SPHQ is limited to the stocks of the S&P 500. While that has been a great place to be for over a decade, that could change. For instance, if the market shifted its emphasis toward smaller U.S. stocks, non-U.S. stocks or both, this ETF might not be as attractive given that limitation.
The strict requirements of this ETF's construction methodology can backfire as well. Its insistence on including all 11 market sectors might allow some lesser-quality companies to sneak into the portfolio. This is also not a very high yielder. The dividend tends to be roughly in the same range as the S&P 500, which is not particularly high in most market environments.
Opportunities
The current market environment could very transition to what Wall Street calls a "flight to quality." That is, meme stocks and companies with hope but not earnings and stable businesses could fall out of favor, as investors flock to more consistent, higher-quality names. SPHQ could be a prime beneficiary of such a market climate. This ETF runs a focused portfolio, so as the market continues its volatile ways, investors can quickly know what they own and what's moving this asset in their portfolio.
Threats
This is still an equity ETF, and the equity market is very shaky right now. In addition, the significant allocation to energy and technology stocks is something that could produce more volatility as the bear market continues to work itself out.
Conclusions
ETF Quality Opinion
I like this ETF's structure as much as any I have found in the U.S. equity category. It does a lot of work for an investor, using some straightforward quantitative measures, while placing restrictions in the right places (such as the caps on position and sector size within the portfolio). This is one I will be following for sure.
ETF Investment Opinion
I rate SPHQ a buy. While no equity ETF can be considered a high-probability winner in the short term, given the variety of market concerns this analysis is about an intermediate- to long-term time frame. And, over that time frame, I like SPHQ as one of the better core equity ETFs out there.
Modern Income Investor's proprietary technical rating system was created by the firm's founder, Rob Isbitts, a chartist for more than 40 years. The ratings emphasize risk-management, and the belief that while any investment can appreciate in price at any time, each investment carries a different level of potential for major loss. The balance of reward and risk is calculated each night for thousands of securities, using a formula that analyzes price trend, strength of that trend and key price levels. It analyzes data over multiple time frames to produce a short-term rating (looking three months out) and a long-term rating (looking 12 months out).
For further details see:
SPHQ: A Smart And Innovative Angle On Large-Cap Investing