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Are Stock Quality ETFs Working?

Posted in Fundamental Valuation

Are stock quality strategies, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider four ETFs, all currently available (from oldest to youngest):

  • Invesco S&P 500 Quality ETF (SPHQ) - seeks to track performance of S&P 500 stocks with the highest quality scores based on firm return on equity, accruals ratio and financial leverage ratio, reformed semi-annually.
  • iShares Edge MSCI USA Quality Factor ETF (QUAL) - seeks to track performance of U.S. large-capitalization and mid-capitalization stocks selected based return on firm equity, earnings variability and debt-to-equity.
  • Fidelity Quality Factor ETF (FQAL) - seeks to track performance of U.S. large-capitalization and mid-capitalization stocks with a higher firm quality profile than the broader market.
  • Vanguard U.S. Quality Factor ETF (VFQY) - applies a rules-based quantitative model to select U.S. common stocks with strong fundamentals (strong profitability and healthy balance sheets) across market capitalizations, sectors and industry groups.

Because some available sample periods are very short, we focus on daily return statistics, along with cumulative returns and maximum drawdowns. We use three benchmarks according to fund descriptions: SPDR S&P 500 (SPY), Vanguard Russell 1000 Index Fund ETF (VONE) and iShares Russell 3000 ETF (IWV). Using daily returns for the four stock quality ETFs and benchmarks as available through most of July 2019, we find that:

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