QUAL: Performing As Predicted, Staying Bullish
This article emphasizes the iShares MSCI USA Quality Factor ETF (BATS:QUAL) as I assess the market from a systematic vantage point. Although it possesses idiosyncrasies, the QUAL ETF is primarily driven by systemic factors, meaning a parsimonious view of the vehicle can be productive.
We last assessed QUAL ETF in May, stating that its attributes aligned with the implied economic environment. A bullish rating was assigned to the ETF, which has paid off, as QUAL ETF has outperformed the S&P 500 ever since. However, talks of an interest rate pivot mean a changing capital market environment is set to emerge, allowing me to update our thesis.
Without further ado, here are my latest thoughts about the iShares MSCI USA Quality Factor ETF’s prospects.
Recent Performance
The following diagram dispenses a regression analysis whereby I tested systematic risk’s influence on QUAL ETF. The regression’s adjusted R-squared shows that approximately 97.3% of the fund’s returns are likely explained by the fama-french five-factor model, substantiating my earlier claim that QUAL ETF is primarily influenced by systematic risk.
Aside: If you don’t know what factors are, here is a link that explains the concept.
As previously mentioned, QUAL ETF has outperformed the S&P 500 since our latest coverage. However, its total return fell short, likely due to a lower dividend distribution policy.
Some investors might prefer income-based assets, while others prefer capital gains. I outline the juxtaposition, allowing you to interpret it your own way.
Quality Factor Exposure In Today’s Market
A glance at some of the U.S.’s primary factors shows that quality stocks have performed at the 50th percentile since the turn of the year. However, noticeable performance occurred between late July and the start of August.
Polen Capital recently executed a regression analysis, assessing the MSCI USA Quality Index’s performance in relation to the economic cycle. The regression, which ranged between December 1975 and March 2023, discovered that the MSCI USA Quality Index outperforms during early-stage, late-stage, and recessionary economic environments. Moreover, the study shows that quality stocks tend to underperform in early-stage expansionary environments.
Polen Capital’s analysis, paired with personal experience, tells me that QUAL ETF is set up to produce favorable results in late 2024 and early 2025.
The basis for my outlook derives from economic persistence and market-based factors.
Factors such as disinflation, speculation of an interest rate pivot, manufacturing PMI below 50, inconsistent consumer confidence, and a waning employment rate suggest the economy is in late-stage growth. Furthermore, the U.S. yield curve has behaved abruptly in recent months, suggesting market participants are unsure about the economy, which fuels my analysis.
I’m not claiming that a recession is inevitable or stating that QUAL ETF’s past relationships will hold. I’m merely echoing my doubtful outlook and saying that I believe QUAL ETF protects against an uncertain economic climate.
Constituents and Key Metrics
Constituency: Valuation and Growth Metrics
The iShares MSCI USA Quality Factor ETF invests in high-quality companies with robust earnings and low leverage. Therefore, I’m unsurprised and unhinged by the ETF’s price-to-earnings multiple of 29.29x (which many might consider high). Moreover, over a third of the ETF’s portfolio spans high-growth technology stocks, so I’m unconcerned by its price-to-book ratio of 8.49x.
I embedded a table below that illustrates the optics of QUAL ETF’s portfolio. The table shows that the ETF’s top ten constituents have high compound annual growth rates and robust return on equity metrics. Given its mandate, I believe the lower end of QUAL ETF’s portfolio follows a similar theme.
Stock | 5Y CAGR | 5Y AVG ROE |
NVIDIA (NVDA) | 56.73% | 41.99% |
Apple (AAPL) | 8.28% | 123.11% |
Microsoft (MSFT) | 14.26% | 42.80% |
Eli Lilly and Co. (LLY) | 12.42% | 91.76% |
Visa Inc. (V) | 9.41% | 40.97% |
Mastercard Inc (MA) | 10.94% | 143.90% |
Meta Platforms (META) | 19.06% | 25.11% |
UnitedHealth (UNH) | 10.32% | 25.13% |
Costco (COST) | 11.14% | 28.16% |
Johnson & Johnson (JNJ) | 1.26% | 24.29% |
Source: iShares, Seeking Alpha (QUAL’s Top 10 Span Around 40% Of Its Portfolio)
Peer-Based Analysis: Expenses and Dividend
I compared QUAL ETFs to similar ETFs to gain a better understanding of QUAL ETF’s expenses and dividends. Although I used JQUA ETF (JQUA), FQAL ETF (FQAL), and SPHQ ETF (SPHQ), other peers exist, so I encourage you to do your own peer-based analysis.
QUALT ETF’s expense ratio is in line with those of its peers, which I find commendable given its much larger assets under management. Furthermore, the ETF’s dividend yield is similar to those of its peers, although its dividend growth rate is lower.
Furthermore, as illustrated below, QUAL ETF has outpaced its peers since the start of the year, which, I think, is a defining factor as it can illustrate investor preference.
Limitations Of The Analysis
The primary limitation of this analysis is that it assumes past relationships will hold. Data can be non-stationary, meaning future relationships often diverge from past relationships. Therefore, subjectivity related to the optics of the regression analysis must be considered.
Another limitation of the analysis relates to my economic assumptions. My analysis assumed the economy had reached its peak and failed to consider alternative pathways. As such, the basis of my forecast can be called into question.
Concluding Thoughts
We covered the iShares MSCI USA Quality Factor ETF in May, stating that it would present compelling results through systematic support. After examining the current status of the stock market’s systematic variables, I decided to affirm my bullish outlook, as I believe an uncertain macroeconomic environment provides tailwinds to high-quality stocks.
My Consensus: Market Outperform.