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Combining Quality and Value

In the past year, investors have been rewarded by focusing on quality companies. Shares of companies with strong balance sheets and consistent earnings and cash flow have performed relatively well. Indeed, the iShares MSCI Quality Factor ETF (QUAL) was up 11% as of May 14. While many advisors believe this trend will persist, another factor is also viewed favorably: value. 

During an April webcast with Invesco, VettaFi asked advisors some questions. One was: “Which rewarded factor do you expect to register the strongest performers from now into year end?” Quality (37%) and value (36%) were overwhelmingly the most popular. Momentum (16%), small size (5%), low volatility (3%), and yield (3%) were also chosen. 

ETFs solely focused on value metrics such as book-to-price and earnings-to-price tend to favor more cyclical sectors. For example, the SPDR S&P 500 Value ETF (SPYV) recently had 23% in financials, 18% in healthcare, and 12% in industrials. Meanwhile, there was just 8% in information technology stocks. 

Combining Quality and Value in One ETF 

We recently covered quality ETFs focused on free cash flow ETFs like the VictoryShares Free Cash Flow ETF (VFLO) as well as funds that combine growth and quality. 

Let’s look at ETFs that combine quality with value in one portfolio. 

The VanEck Morningstar Wide Moat ETF (MOAT) is a $15 billion ETF. The fund owns shares of companies Morningstar believes has competitive advantages that are trading below their estimated fair value. Healthcare (21% of assets), industrials (18%), information technology (15%), and financials (14%) comprised the biggest weightings in MOAT. Charles Schwab, Teradyne, and Tyler Technologies are some of the fund’s largest holdings.

The American Century US Quality Value ETF (VALQ) is another fund example. The $220 million index-based ETF combines quality with value and dividends. A quality screen seeks to eliminate the bottom of the universe of stocks based on measures of profitability, earnings quality, management quality, leverage, and momentum. A valuation score is computed for the remaining stocks, determined by the attractiveness of each stock relative to its peers in the same industry group based on value, earnings yield, and cash flow yield metrics. An income screen based on dividend yield is applied to eliminate the bottom of the universe of dividend-paying stocks.   

Industrials (21% of assets), information technology (21%), and consumer staples (17%) well represent the resulting portfolio. Colgate Palmolive, Illinois Tool Works, and Qualcomm are examples of VALQ’s 230 holdings. 

Another index ETF is the Alpha Architect US Quantitative Value ETF (QVAL). The strategy seeks to buy the cheapest, highest-quality value stocks. This multicap fund starts with 1,500 stocks, but based on value and quality screening, ends up with a portfolio of just 50. AT&T, Delta Airlines, Signet Jewelers, and Terex were some of the recent top-10 holdings. QVAL had $340 million in assets. 

Turning to Active Management 

The Hartford Quality Value ETF (QUVU) takes an active approach. Management seeks out high-quality, undervalued companies believed to be in out-of-favor industries with less downside risk than the overall market. Financials (21% of assets), healthcare (15%), and information technology (11%) comprised the largest sectors of the fund. JPMorgan Chase, Merck, and Wells Fargo were the largest recent positions for the $175 million ETF. 

One of the benefits of ETFs is the ability to obtain targeted exposure. However, it remains important to look inside the portfolio, as ETFs that sound the same are often not the same.  

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