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Bet on Quality ETFs as Fed Keeps Rate Steady, View Hawkish

The Federal Reserve, as expected, kept interest rates steady at a 22-year high in the range of 5.25% to 5.5% but signaled one more hike this year. Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have slowed in recent months but remain strong and the unemployment rate has remained low. The U.S. banking system is also deemed to be sound and resilient.

Though inflation is easing, it remains elevated and is above the Fed’s 2% target. The ongoing strength in the economy and the surging oil prices threaten to revive inflationary pressures. Twelve members of the FOMC saw one more rate hike this year, while seven members wanted to keep rates at current levels through year-end (read: 5 Ways to Hedge Against Inflation With ETFs).

The Fed’s decision to stand pat will provide a reprieve to consumers who have been hit by steady increases in rates for credit cards, adjustable-rate mortgages and other loans. Tighter credit conditions for households and businesses are expected to affect economic activity, hiring and inflation.

Amid a still-hawkish Federal Reserve scenario, quality investing seems to be a solid bet. Quality stocks possess a sustainable competitive advantage and demonstrate consistent growth, profitability and operational excellence over time. We have highlighted solid reasons for investing in quality stocks.

Long-Term Outperformance: Historically, high-quality companies consistently deliver superior risk-adjusted returns than the broader market over the long term. This is because quality companies have strong fundamentals that can weather economic downturns better than their weaker counterparts.

Consistent Profitability: Quality companies tend to have a high return on equity (ROE), return on invested capital (ROIC) and profit margins. These are indicators of a company's ability to generate profit consistently.

Lower Volatility: Quality stocks tend to exhibit lower volatility compared to the broader market. Their robust business models and financial strength make them less susceptible to market fluctuations, leading to a smoother investment journey (read: Low Volatility ETFs to Outperform: Here's Why).

Defensive Nature: During economic downturns, quality stocks often prove more resilient as they have strong balance sheets, low levels of debt and cash reserves to tide them over during challenging times.

Compounding Effect: Investing in quality companies allows investors to benefit from the power of compounding. As these companies consistently grow their earnings and reinvest them, shareholders can achieve exponential returns over time.

Strong Brand and Moat: Quality companies often possess strong brands and competitive moats, which protect them from competition. This can lead to a sustainable competitive advantage, ensuring long-term profitability.

Transparency and Governance: High-quality companies usually have transparent financial reporting and sound corporate governance. This reduces the chances of any unwelcome surprises and can potentially reduce investment risk.

Value Preservation: In uncertain or declining market environments, quality stocks can serve as a relative safe haven, preserving capital better than more speculative or lower-quality investments.

Growth Potential: Even if they are established leaders, many quality companies still have significant room for growth, especially if they operate in expanding industries or have opportunities to penetrate new markets.

Dividend Payouts: Quality companies often have a history of paying consistent dividends, providing a source of income for investors. Moreover, since they are usually in a strong financial position, there's a good chance for steady or even increasing dividend payouts in the future (read: 5 Dividend ETFs That Are on Sale).

ETFs to Bet

While there are several funds available in the space, we have highlighted five most popular ETFs targeting the niche strategy:

iShares MSCI USA Quality Factor ETF (QUAL)

With an AUM of $32.2 billion, iShares MSCI USA Quality Factor ETF provides exposure to large and mid-cap stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth and low financial leverage) by tracking the MSCI USA Sector Neutral Quality Index. QUAL holds 125 stocks in its basket, with each making up not more than a 6% share.

iShares MSCI USA Quality Factor ETF charges 15 bps of annual fees and trades in an average daily volume of 1.4 million shares.

Invesco S&P 500 Quality ETF (SPHQ)

Invesco S&P 500 Quality ETF tracks the S&P 500 Quality Index, a benchmark of S&P 500 stocks with the highest-quality score based on three fundamental measures, such as return on equity, accruals ratio and financial leverage ratio.

Holding 102 stocks in its basket, Invesco S&P 500 Quality ETF amassed $6 billion in its asset base and trades at an average daily volume of 6595,000 shares. SPHQ charges 15 bps in fees per year (read: Quality Equity ETF Hits New 52-Week High).

JPMorgan U.S. Quality Factor ETF (JQUA)

JPMorgan U.S. Quality Factor ETF provides domestic equity exposure with a focus on companies with strong quality and profitability characteristics and the potential to enhance returns. It tracks the JP Morgan US Quality Factor Index and holds 258 stocks in its basket, with each accounting for no more than 2.1% share.

JPMorgan U.S. Quality Factor ETF has amassed $2.2 billion in its asset base and charges 12 bps in fees per year. It trades in average daily volume of 379,000 shares.

FlexShares Quality Dividend Index Fund (QDF)

FlexShares Quality Dividend Index Fund is designed to provide exposure to a high-quality income-oriented portfolio of long-only U.S. equity securities, with an emphasis on long-term capital growth and a targeted overall beta that is similar to that of the Northern Trust 1250 Index. QDF is home to 143 stocks in its basket, with none making up for more than 9.1% of assets.

FlexShares Quality Dividend Index Fund accumulated $1.6 billion in its asset base and trades in an average daily volume of 36,000 shares. QDF charges 37 bps as fees per year from investors.

SPDR MSCI USA StrategicFactors ETF (QUS)

SPDR MSCI USA StrategicFactors ETF offers exposure to stocks that combine low volatility, quality and value factor strategies. This is done by tracking the MSCI USA Factor Mix A-Series Capped Index. SPDR MSCI USA StrategicFactors ETF holds 625 stocks in its basket, with each accounting for less than 3% share.

SPDR MSCI USA StrategicFactors ETF attracted $1 billion in its asset base and trades in an average daily volume of 18,000 shares. QUS charges 15 bps of fees per year from investors.

Bottom Line

Quality ETFs often provide a hedge against market volatility. Adding any of the abovementioned products to one’s long-term portfolio could be a healthy move, given their creditworthiness and soundness.

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iShares MSCI USA Quality Factor ETF (QUAL): ETF Research Reports

FlexShares Quality Dividend ETF (QDF): ETF Research Reports

Invesco S&P 500 Quality ETF (SPHQ): ETF Research Reports

SPDR MSCI USA StrategicFactors ETF (QUS): ETF Research Reports

JPMorgan U.S. Quality Factor ETF (JQUA): ETF Research Reports

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Zacks Investment Research