Quality ETFs
A quality ETF is a so-called "smart beta" ETF that select stocks based on one or more measures as to whether the company is a "quality" company. Although there is not necessarily a hard and fast rule, a quality company is typically considered to be a profitable company with high earnings. Some people will also imply that to be a quality company, a company must have a "good balance sheet" or be "fundamentally sound", but at stoxray.com, when we talk about the quality factor, we are referring to any ETF that selects stocks using one or more measures of the earnings of a company.
How do you measure whether a company is a profitable company? Various quality indexes are using a wide variety of methods to measure a company's earnings:
- Net income
- Return on equity, which is a company's net income as a percentage of the company's stockholders' equity
- Return on assets, which is a company's net income as a percentage of the company's total assets
- Free cash flow, which is typically how much of a company's net income is left over after debt service
Academic factor research has usually concluded that quality is one of the significant factors that can lead to one company's stock outperforming the market. Fama French measured quality by looking at a company's net operating income. Hou Xue and Zhang measured quality using a company's return on equity.
Here are the quality ETFs that only use quality as an investment factor (i.e. they are not multi-factor ETFs), if you want to read some examples of the approaches taken by quality ETFs:
| Name | Symbol | Last price | Currency | AUM | Expense ratio, % | Inception date |
|---|---|---|---|---|---|---|
| iShares MSCI USA Quality Factor ETF | BATS:QUAL | 168.16 | USD | 51,255,084,433 | 0.15 | Jul 18, 2013 |
| Invesco S&P 500 Quality ETF | XNYS:SPHQ | 67.24 | USD | 12,079,617,480 | 0.15 | Dec 06, 2005 |
| iShares MSCI Intl Quality Factor ETF | ARCX:IQLT | 39.89 | USD | 7,991,407,840 | 0.30 | Jan 21, 2015 |
| JPMorgan U.S. Quality Factor ETF | ARCX:JQUA | 55.41 | USD | 4,405,366,000 | 0.12 | Nov 09, 2017 |
| Nuveen Growth Opportunities ETF | ARCX:NUGO | 30.49 | USD | 2,584,904,388 | 0.56 | Sep 28, 2021 |
| FlexShares Quality Dividend Index Fund | ARCX:QDF | 67.20 | USD | 1,758,297,776 | 0.37 | Dec 19, 2012 |
| iShares U.S. Small-Cap Equity Factor ETF | ARCX:SMLF | 60.91 | USD | 1,505,619,969 | 0.15 | Apr 30, 2015 |
| SPDR MSCI USA StrategicFactors ETF | ARCX:QUS | 152.57 | USD | 1,479,350,000 | 0.15 | Apr 15, 2015 |
| American Century U.S. Quality Growth ETF | ARCX:QGRO | 91.68 | USD | 1,119,168,525 | 0.29 | Sep 12, 2018 |
| Fidelity Quality Factor ETF | ARCX:FQAL | 63.12 | USD | 1,062,495,752 | 0.16 | Sep 16, 2016 |
| SPDR MSCI EAFE StrategicFactors ETF | ARCX:QEFA | 79.35 | USD | 936,120,000 | 0.30 | Jun 04, 2014 |
| WisdomTree U.S. LargeCap Fund | ARCX:EPS | 58.38 | USD | 911,805,165 | 0.08 | Feb 23, 2007 |
| WisdomTree International Quality Dividend Growth Fund | BATS:IQDG | 36.26 | USD | 890,175,600 | 0.42 | Apr 07, 2016 |
| WisdomTree U.S. MidCap Fund | ARCX:EZM | 58.11 | USD | 760,199,040 | 0.38 | Feb 23, 2007 |
| VictoryShares Free Cash Flow ETF | XNAS:VFLO | 33.49 | USD | 755,775,223 | 0.39 | Jun 26, 2023 |
| WisdomTree Trust WisdomTree U.S. Quality Growth Fund | ARCX:QGRW | 43.73 | USD | 673,871,100 | 0.28 | Dec 22, 2022 |
| WisdomTree U.S. SmallCap Fund | ARCX:EES | 48.37 | USD | 595,502,710 | 0.38 | Feb 23, 2007 |
| FlexShares International Quality Dividend Index Fund | ARCX:IQDF | 24.99 | USD | 564,281,664 | 0.47 | Apr 16, 2013 |
| Vident U.S. Equity Strategy ETF | XNYS:VUSE | 45.49 | USD | 544,435,260 | 0.50 | Jan 22, 2014 |
| Invesco International Developed Dynamic Multifactor ETF | BATS:IMFL | 24.74 | USD | 493,869,824 | 0.34 | Feb 24, 2021 |
| Invesco S&P SmallCap Quality ETF | XNYS:XSHQ | 42.27 | USD | 403,448,805 | 0.29 | Apr 06, 2017 |
| FlexShares Quality Dividend Defensive Index Fund | ARCX:QDEF | 68.80 | USD | 378,896,736 | 0.37 | Dec 19, 2012 |
| FlexShares Global Quality Real Estate Index Fund | ARCX:GQRE | 56.55 | USD | 336,048,627 | 0.45 | Nov 06, 2013 |
| SEI Enhanced U.S. Large Cap Quality Factor ETF | BATS:SEIQ | 33.91 | USD | 233,657,244 | 0.15 | May 19, 2022 |
| American Century U.S. Quality Value ETF | ARCX:VALQ | 59.69 | USD | 221,700,762 | 0.29 | Jan 16, 2018 |
| FlexShares Trust FlexShares US Quality Large Cap Index Fund | BATS:QLC | 62.78 | USD | 215,337,325 | 0.25 | Sep 24, 2015 |
| Pacer US Large Cap Cash Cows Growth Leaders ETF | XNAS:COWG | 30.38 | USD | 183,938,680 | 0.49 | Dec 30, 2022 |
| SPDR MSCI World StrategicFactors ETF | ARCX:QWLD | 126.22 | USD | 149,230,000 | 0.30 | Jun 04, 2014 |
| iShares Global Equity Factor ETF | ARCX:GLOF | 42.56 | USD | 115,851,855 | 0.20 | May 04, 2015 |
| Virtus ETF Trust II Virtus Terranova U.S. Quality Momentum ETF | XNAS:JOET | 35.58 | USD | 111,041,832 | 0.29 | Nov 19, 2020 |
| Natixis ETF Trust Natixis Gateway Quality Income ETF | ARCX:GQI | 50.37 | USD | 101,028,495 | 0.34 | Dec 13, 2023 |
| Columbia U.S. Equity Income ETF | ARCX:EQIN | 44.27 | USD | 81,583,712 | 0.35 | |
| FlexShares International Quality Dividend Dynamic Index Fund | ARCX:IQDY | 29.21 | USD | 65,009,528 | 0.47 | Apr 16, 2013 |
| Pacer US Export Leaders ETF | ARCX:PEXL | 45.41 | USD | 61,444,370 | 0.60 | Oct 18, 2018 |
| Columbia Research Enhanced Emerging Economies ETF | ARCX:ECON | 21.75 | USD | 49,857,500 | 0.49 | Sep 14, 2010 |
| SPDR MSCI Emerging Markets StrategicFactors ETF | ARCX:QEMM | 57.54 | USD | 44,770,000 | 0.30 | Jun 04, 2014 |
| Invesco Investment Grade Defensive ETF | ARCX:IIGD | 24.41 | USD | 44,011,824 | 0.13 | Jul 25, 2018 |
| ETRACS 2x Leveraged MSCI US Quality Factor TR ETN | ARCX:QULL | 42.19 | USD | 43,002,800 | 0.95 | Feb 09, 2021 |
| ETC 6 Meridian Quality Growth ETF | ARCX:SXQG | 29.35 | USD | 41,471,743 | 1.00 | May 12, 2021 |
| FlexShares International Quality Dividend Defensive Index Fund | ARCX:IQDE | 20.60 | USD | 21,554,521 | 0.47 | Apr 16, 2013 |
| Pacer US Small Cap Cash Cows Growth Leaders ETF | XNAS:CAFG | 22.76 | USD | 14,835,750 | 0.59 | May 02, 2023 |
| J.P. Morgan Exchange-Traded Fund Trust JPMorgan Active China ETF | ARCX:JCHI | 49.66 | USD | 10,498,800 | 0.65 | Mar 17, 2023 |
| Matthews International Funds Matthews Asia Dividend Active ETF | ARCX:ADVE | 32.25 | USD | 1,606,600 | 0.79 | Sep 18, 2014 |
Do quality ETFs outperform?
In general, it is very difficult to reach conclusions about smart beta ETFs because they use so many different approaches to selecting and weighting stocks. Literally, no two smart beta ETFs seem to be the same. And they have such limited history. Quality ETFs, in particular, are using a lot of different approaches to selecting "quality" stocks.
As a stand-alone factor, the quality factor can lead to some outperformance, although it is not always dramatic. Let's look at a few examples.
EPS, the WisdomTree Earnings 500 Fund ETF, seems to be screening and weighting stocks using the classic definition of a "quality" company - companies with high core earnings. Yet it doesn't seem to make a difference, as EPS and SPY are closely correlated.
EZM, the WisdomTree MidCap Earnings Fund ETF, screens and weights stocks using core earnings, but it only includes mid cap stocks in its index. It has slightly outpeformed MDY, which tracks the S&P Mid cap 400 Index:
EES, the WisdomTree SmallCap Earnings Fund ETF, screens and weights stocks using core earnings, but it only includes smallcap stocks in its index. It has slightly outpeformed IJR, which tracks the S&P Smallcap 600 Index:
Conclusion
The evidence to date is not very convincing that the quality factor by itself plays a huge role in picking stocks. EES and EEM seem to indicate that picking stocks based on the company's earnings helps, particularly in the case of mid and small cap stocks, but the evidence is not overwhelming. Said another way, there hasn't been an ETF invented yet that has been able to significantly outperform the major indexes merely by screening for profitable companies.