While the markets have spent most of the past year focused on tech and, more specifically, the Magnificent 7 stocks, one other group has quietly been performing very well — quality stocks.
The "quality" factor targets companies that are in a financially healthy position. That could be determined by looking at cash flows, debt levels, profitability or the level of reinvestment back into the business. These screens generally produce portfolios filled with durable companies that have the means to continue growing and rewarding shareholders.
IShares MSCI USA Quality Factor ETF
The strategy of the iShares MSCI USA Quality Factor ETF looks at these metrics in particular — return on equity (ROE), debt-to-equity ratio and a track record of earnings consistency. This ensures that the companies selected for the portfolio are profitable and not highly leveraged. These quality stocks can reasonably be expected to continue generating earnings growth well into the future.
You might look at this strategy and infer that it includes stodgy or boring companies from the consumer staples or utilities sectors. But that's actually not the case. The fund's largest individual sector holding is tech, accounting for more than 31% of assets.
That's more than even the S&P 500. Don't want to give up the "Magnificent 7" exposure in your portfolio? The iShares MSCI USA Quality Factor ETF fits the bill.
Nvidia, Microsoft, Meta Platforms and Apple are all among the fund's top 10 holdings.
Quality Stocks With An Unexpected Pop Of Growth
This gives QUAL some growth pop that investors may not expect. It's not entirely surprising though given how the AI revolution is driving some of the biggest earnings growth in the economy right now. Semiconductor makers, such as Nvidia, are already experiencing a huge boom in demand for its products and that demand is likely to continue spreading across the sector.
Tech is currently expected to deliver the biggest earnings growth in 2024.
While that tech overweight helped to produce a 31% total return for shareholders in 2023, topping the 26% gain for the S&P 500, QUAL has been a strong performer for much longer than that.
Over the past 10 years, its 12% average annual return has roughly matched that of the S&P 500 and it has gained nearly 13% annually since its launch in mid-2013. All of that has earned QUAL Morningstar's highest 5-star rating in the Large Blend category.
Positioned To Pivot For Long-Term Success
This fund has certainly taken advantage of the recent rally in tech. Yet one of its real benefits is that it can pivot if conditions for any particular company or sector change. If financial performance starts to deteriorate, it's removed. If a company starts hitting on all cylinders, it can be added. The fund is reviewed and rebalanced semiannually. That means it never needs to wait too long in order for any changes to be reflected in the portfolio.
The markets have been very focused on tech and growth stocks over the past year. However, strategies focused on quality stocks backed by strong balance sheet fundamentals are built for the long-term. They have demonstrated the ability to lead in stronger markets. Investors may prefer the financial health of quality companies in more challenging markets as well. The iShares MSCI USA Quality Factor ETF has a rock-bottom 0.15% expense ratio. That makes it one of the most cost-effective ways to add this to your portfolio.
