Wall Street has been on a scary ride in recent weeks amid escalating trade disputes, concerns over a slowing economy and growing geopolitical tensions. Though the Fed reaffirmed its forecast for two rate cuts this year, it expects higher inflation and slower economic growth. These combinations have raised heightened volatility and uncertainty in the market.

In such a scenario, investors should focus on high-quality investing. Quality stocks possess a sustainable competitive advantage and demonstrate consistent growth, profitability and operational excellence over time. While there are several funds available in the space, we have chosen the five most popular ETFs targeting the niche strategy. These are iShares MSCI USA Quality Factor ETF QUAL, Invesco S&P 500 Quality ETF SPHQ, JPMorgan U.S. Quality Factor ETF JQUA, FlexShares Quality Dividend Index Fund QDF and SPDR MSCI USA StrategicFactors ETF QUS.

The barrage of recent data, including surveys and sentiment indicators, suggests a downturn in the economy. Per the latest BofA survey, the fund managers, who were bullish on the U.S. markets till last month, are now 23% underweight on U.S. equities, down 40 percentage points from the previous survey. The allocation to U.S. equities has hit the lowest level since June 2023.

According to Goldman, hedge funds added more bearish positions than bullish ones in March than at any time since 2020, doubling down on bets that U.S. stocks are likely to fall further. After the first week in March, hedge funds abandoned their stock holdings over 48 hours at the fastest rate in four years.

Why Quality?

Quality ETFs often provide a hedge against market volatility and uncertainty. We have highlighted some solid reasons for investing in quality stocks.

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.

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

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 (read: Value ETF Investing: Positioned to Thrive in Uncertain Markets).

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.

Long-Term Outperformance: Historically, high-quality companies have consistently delivered superior risk-adjusted returns compared with 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.

Compounding Effect: Betting on 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.

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.

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 typically in a strong financial position, there is a good chance of steady or even increasing dividend payouts in the future.

ETFs to Invest 

iShares MSCI USA Quality Factor ETF (QUAL)

With an AUM of $48.7 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 123 stocks in its basket and charges 15 bps in annual fees. It trades in an average daily volume of 1.5 million shares and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: Recession Fears Looming? Secure Your Portfolio With These ETFs). 

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 has amassed $11.6 billion in its asset base and trades in an average daily volume of 1 million shares. It charges 15 bps in fees per year and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.

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 284 stocks in its basket. JPMorgan U.S. Quality Factor ETF has amassed $6 billion in its asset base and charges 12 bps in fees per year. It trades in an average daily volume of 709,000 shares. 

FlexShares Quality Dividend Index Fund (QDF)

FlexShares Quality Dividend Index Fund tracks the Northern Trust Quality Dividend Index. It is home to 143 stocks in its basket and charges 37 bps in fees per year. FlexShares Quality Dividend Index Fund has accumulated $1.8 billion in its asset base and trades in an average daily volume of 36,000 shares. It has a Zacks ETF Rank #3 with a Medium risk outlook.

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 576 stocks in its basket and charges 15 bps in fees per year from investors. It has attracted $1.4 billion in its asset base and trades in an average daily volume of 25,000 shares. QUS has a Zacks ETF Rank #3 with a Medium risk outlook.
 

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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

This article originally published on Zacks Investment Research (zacks.com).

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