3 Quality ETFs To Trump Market Turmoil

The global stock market has been on a wild ride over the past few weeks. The wave of intense selling was initially triggered by the surprise devaluation of the Chinese currency last month. The move not only derailed the stock market but also accelerated the slump in commodities and emerging market currencies, raising global growth worries.

The damage was aggravated by lower oil prices, sluggishness in other developed and developing markets, a strong dollar, and an uncertain Fed policy. In particular, the ambiguity over rising rates has taken the front seat this week as the Fed policy meeting is to be held on September 16–17. According to the poll by Reuters in August, the Fed is expected to pull its trigger on the first rates hike in almost a decade in this scheduled meeting though relentless slowdown in China and the recent global market turmoil is dimming the prospects (read: 4 ETF Areas to Watch Ahead of the Fed Meeting).

Whatever the case, the bullish sentiment for U.S. stocks remains intact. This is especially true as near-zero rates have allowed the U.S. stock market to complete a spectacular six-year bull-run and even if the rates rise, the initial phase would actually be good for stocks, as it would reflect an improving economy and a lower risk of deflation.

Further, the U.S. economy has been on a firmer footing, and could easily withstand China and global growth worries. Most economic data points have confirmed this trend. The second estimate of Q2 GDP data came in much higher than the initial estimate, the housing market is improving, consumer confidence is rising, and the unemployment rate dropped to a seven-and-half year low. While a lower oil price is hurting its sector earnings and creating deflationary pressures, it is leading to fatty wallets and increased consumer spending. Moreover, the recent beaten down prices has made the stocks cheap at current levels, suggesting solid attractive points.

However, heightened volatility and uncertainty have made investors cautious about their stock investments. It would thus be better to focus on fundamentals and invest in “high-quality” stocks through a basket form.
 
High Quality ETFs in Focus

High quality ETFs are generally rich on value characteristics as they focus on stocks with high quality scores based on three fundamentals – high return on equity, stable earnings growth and low financial leverage. This approach seeks investments in safer stocks and reduces volatility when compared to plain vanilla funds.

Further, academic research shows that high quality companies consistently deliver superior risk-adjusted returns than the broader market over the long term. More importantly, these stocks generally outperform in a crumbling market.

While several quality ETFs are currently available in the market, with most of them focusing on the dividend aspect, we have highlighted three funds that hinge on the broad quality aspects. These products have crushed the broad market fund (SPY - ETF report) by wide margins over the long term and year-to-date timeframe and are expected to continue doing so (read: 6 Exceptional ETFs Up Over 15% YTD).

MSCI USA Quality Factor ETF ((QUAL - ETF report))

This fund tracks the MSCI USA Sector Neutral Quality Index and provides exposure to large and mid-cap U.S. stocks exhibiting positive fundamentals. In total, the fund holds 125 securities in its basket, which are pretty spread across number of sectors and securities. The top three firms – Johnson & Johnson (JNJ), Microsoft (MSFT - Analyst Report) and Apple (AAPL - Analyst Report) – together make up for nearly 13.5% of assets. Information technology, financials, healthcare and consumer discretionary each accounts for double-digit exposure.

The product has amassed $1.1 billion in its asset base and charges just 15 bps in annual fees from investors. However, average trading volume is moderate at around 88,000 shares per day, suggesting a wide bid/ask spread. The ETF is down modestly 0.6% in the year-to-date timeframe.

PowerShares S&P 500 High Quality ETF ((SPHQ - ETF report))

This fund follows the S&P 500 High Quality Rankings Index, a benchmark of S&P 500 stocks that have solid long-term growth as well as stable earnings and dividends. This approach has resulted in a basket of 133 stocks with none holding more than 1.43% of total assets. CH Robinson Worldwide (CHRW - Analyst Report), Hormel Foods (HRL - Analyst Report) and Raytheon (RTN - Analyst Report) are the top three elements in the basket (see: all the Large Cap ETFs here).

The fund is skewed toward industrials at 26.9%, followed by consumer staples and consumer discretionary with at least 18% share each. The product has managed nearly $500 million in AUM and trades in good volume of more than 121,000 shares per day on average. Expense ratio came in at 0.29%. SPHQ has lost over 3.4% so far this year.

SPDR MSCI USA Quality Mix ETF ((QUS - ETF report))

This fund offers exposure to the stocks that have a combination of value, low volatility and quality factor strategies. This is done by tracking the MSCI USA Quality Mix A-Series Index. The product holds a large basket of 620 stocks, which are highly diversified across each component as none holds more than 2.93% of assets. Exxon Mobil (XOM - Analyst Report), Apple and JNJ occupy the top three positions.

The ETF is slightly tilted toward information technology sector while healthcare, financials and consumer discretionary round off the next three spots with double-digit exposure each. The fund has accumulated $5.7 million in AUM since its debut five months ago. It charges 15 bps in fees per year from investors and trades in a paltry average daily volume of under 1,000 shares. The product has shed 5.4% since its inception.
 

In Conclusion

Quality ETFs often provide hedge against market volatility, which has intensified due to the China-led deceleration fears. Adding any of the above-mentioned stocks to one’s long-term portfolio could be worthwhile thanks to their credit worthiness and soundness. Further, the current market correction is a great time to buy the high-quality names at an attractive price.