Benefitting from Quality Businesses
Investing in quality has proven to be a beneficial strategy over the long term.
A typical, but amusing event occurred in November 2023 with Amazon.com Inc., as the firm announced a new digital shopping experience where customers would be able to buy a car online in 2024. Hyundai will be the first brand available on the site as part of a partnership between the two brands. The amusing part of this announcement was the subtext – there is seemingly no venture or business vertical this company will not enter into. The reaction to this announcement was typical, online vehicle marketplaces Cars.com, CarMax, Carvana, and others took a hit after the announcement, as this directly impacted their line of business.
Gleaned from this announcement, and the history of Amazon.com Inc., is an investment truism - high-quality businesses continually find ways to reward their investors. This article will briefly explain the quality investment factor and highlight ETFs that allow investors to access it.
Quality as an investment strategy
Quality factor investing is an investment strategy that focuses on identifying and selecting high-quality companies for investment. It aims to find companies with strong fundamentals, stable earnings, and robust financial health. The quality factor is based on the idea that high-quality companies tend to outperform their peers over the long term and exhibit resilience during market downturns.
In evaluating a company and characterizing it as high-quality, several fundamental metrics are used to assess and categorize companies as high-quality investments.
Profitability: High-quality companies are often characterized by consistent and robust profitability. Metrics such as return on equity (ROE), return on assets (ROA), and profit margins are used to evaluate a company's ability to generate profits efficiently.
Earnings Stability: Companies with stable and predictable earnings tend to be considered of higher quality. Investors often look for companies with a history of steady earnings growth, low earnings volatility, and a lack of significant earnings surprises.
Financial Health: A company's financial health is an important aspect of its quality. Metrics such as debt levels, interest coverage ratio, and current ratio are used to evaluate a company's ability to meet its financial obligations. High-quality companies typically have lower debt levels, strong liquidity, and the ability to weather economic downturns.
Strong Management: Quality companies are often associated with strong management teams that have a track record of making prudent financial decisions, allocating capital efficiently, and executing effective business strategies.
Competitive Advantage: A sustainable competitive advantage is a key characteristic of high-quality companies. This advantage could be derived from factors such as strong brands, intellectual property, patents, or a dominant market position. Companies with a durable competitive advantage are more likely to generate consistent profits and maintain their market position over time.
In looking at the performance of companies that espouse these attributes, as reflected in the MSCI USA Quality Index and MSCI World Quality Index, they have outperformed their respective parent indices, the MSCI USA Index and MSCI World Index, over varying time periods. The following charts illustrate this, reflecting data as of November 2023.
Quality Factor-focused solutions
The objective of quality factor investing is to build a portfolio of companies with these high-quality characteristics. For investors who desire to invest purely in companies that reflect these attributes, there are numerous investment solutions that provide said exposure on a regional and global scale. The following ETFs are quality-factor focused solutions available to Canadian investors:
The BMO MSCI USA High Quality Index ETF (Ticker: ZUQ) has been designed to replicate, to the extent possible, the performance of the MSCI USA Quality Index. The fund invests in U.S. equity markets while screening for high return on equity (ROE), stable year-over-year earnings growth and low financial leverage.
The BMO MSCI All Country World High Quality Index ETF (Ticker: ZGQ) has been designed to replicate, to the extent possible, the performance of the MSCI All Country World High Quality Index. The fund invests in global equity markets, while screening for high return on equity (ROE), stable year-over-year earnings growth and low financial leverage.
Guardian i3 investment solutions are centered on delivering high risk-adjusted returns and providing investors with building blocks to create sophisticated multi-asset portfolios. The Guardian i3 US Quality Growth ETF (Ticker: GIQU) invests in high-quality and defensive US equities with sustainable earnings growth, avoiding areas of weakness identified through their investment process. The Guardian i³ Global Quality Growth ETF (Ticker: GIQG) seeks to identify and invest in globally oriented companies that reflect the highest quality and growth characteristics. The underlying strength of quality companies is their ability to generate consistently solid earnings growth, which helps to insulate them from down market volatility and to generate alpha opportunities over the longer term and throughout full market cycles.
The Fidelity U.S. High Quality Index ETF (Ticker: FCUQ) seeks to replicate the performance of the Fidelity Canada U.S. High Quality Index. The fund primarily invests in equity securities of large and mid-capitalization U.S. companies with a higher quality profile than the broader U.S. equity market.
Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.
