2023-09-12 15:24:44 ET
Summary
- Invesco S&P 500® Quality ETF focuses on investing in fundamentally strong companies in the S&P 500 Index.
- The SPHQ ETF uses a rigorous quality rating system based on three fundamental measures: return on equity, accruals ratio, and financial leverage ratio.
- The ETF has demonstrated impressive performance, resilience during market downturns, and provides downside protection to investors.
Quality means doing it right when no one is looking. - Henry Ford.
Quality is a word that's thrown around a lot, but defining it without objective quantitative metrics is irrelevant. When we talk about investing in quality, it should have nothing to do with a chart, and everything to do with fundamentals. To that end, if you believe we are in a high-risk juncture and want to stay invested in equities, is there a way to do so by favoring only fundamentally strong companies in an ETF wrapper? Absolutely yes.
The Invesco S&P 500® Quality ETF ( SPHQ ) is based on the S&P 500 Quality Index. This ETF is an excellent example of a fund that employs a rigorous quality rating system to determine its portfolio. SPHQ offers exposure to high-quality stocks from the S&P 500 Index (SP500), which are selected based on a comprehensive quality score calculated using three fundamental measures: return on equity, accruals ratio, and financial leverage ratio.
The Strategy Behind SPHQ
SPHQ applies a systematic approach to identify high-quality stocks. The fund normally invests at least 90% of its total assets in common stocks that make up the S&P 500 Quality Index. This Index tracks the performance of stocks in the S&P 500 Index that have the highest quality score. The score is calculated using three critical measures:
- Return on Equity : This measure is calculated by dividing a company's trailing 12-month earnings by its latest book value per share.
- Accruals Ratio : This measure is computed using the net operating assets change over the last year divided by the company's average net operating assets over the past two years.
- Financial Leverage Ratio : This measure is calculated by dividing a company's total debt by its book value.
The fund rebalances and reconstitutes semi-annually on the third Friday of June and December. This robust methodology ensures that only companies with strong financial metrics are included in the portfolio, thereby aligning with the fund's focus on quality.
Portfolio Composition
SPHQ is diversified across all 11 Global Industry Classification Standard ((GICS)) sectors. However, it is worth noting that the fund's strategy can lead to overweights in certain sectors compared to the broader S&P 500 Index. This isn't necessarily a bad thing, just something to keep in mind.
As of June 30, 2023, the top 10 holdings in SPHQ included prominent companies like Nvidia Corp (my favorite!), Apple Inc, Microsoft Corp, and Mastercard Inc. These companies, known for their robust financial health and strong market position, contribute significantly to the performance of the ETF.
Performance Analysis
SPHQ's investment strategy has led to impressive performance over the years. The fund has been consistently in the top tier of the Large Blend category on Morningstar, demonstrating the investment case for tilting towards fundamentally strong companies.
It's also worth noting that the fund has demonstrated resilience during market downturns, thereby providing a measure of downside protection to investors. This defensive characteristic could be particularly appealing to risk-averse investors looking to weather uncertain market conditions.
Peer Comparison
Some comparable ETFs include the iShares MSCI USA Quality Factor ETF ( QUAL ), the ProShares S&P 500 Dividend Aristocrats ETF ( NOBL ), the iShares Core Dividend Growth ETF ( DGRO ), and the Schwab U.S. Dividend Equity ETF ( SCHD ). These funds also focus on quality stocks, but their methodologies and portfolio compositions may differ.
For instance, QUAL, like SPHQ, invests in high-quality companies within the S&P 500 Index. However, it uses a different methodology to select its components, which results in a different portfolio composition. NOBL, on the other hand, focuses on companies within the S&P 500 that have consistently increased their dividends for at least 25 consecutive years. In terms of performance, while SPHQ has delivered solid returns, it's worth noting that funds like DGRO and SCHD have also demonstrated strong performance.
Potential Risks
While SPHQ offers several potential benefits, it's crucial for investors to be aware of the associated risks. Firstly, like any equity investment, SPHQ is subject to market risk, meaning its value is still dependent on movements in the overall stock market.
Secondly, the fund's focus on quality stocks can sometimes lead to sector concentration. For instance, the fund's current significant exposure to the technology and energy sectors could increase volatility if these sectors experience significant price swings.
Finally, it's essential to remember that while the quality screening process employed by SPHQ helps filter out lower-quality companies, it doesn't guarantee future performance. The fund's performance will still depend on the overall performance of the underlying stocks.
Conclusion
The Invesco S&P 500® Quality ETF is an intriguing investment option for those seeking exposure to high-quality stocks within the S&P 500 Index. Its rigorous quality scoring methodology, diversified portfolio, and solid performance make it an attractive choice for investors. It could be a comparatively better place to allocate to now should we be entering a risk-off regime.
For further details see:
SPHQ: A Time For Quality As Risks Rise