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Within the realm of investing, individuals are afforded the ability to choose a variety of avenues to grow their wealth. Factor-based investing affords investors the ability to construct portfolios with a high degree of precision, reflecting market exposures they desire to have over a long investment time frame. This article will briefly explain the quality investment factor and highlight investment solutions that allow investors to access it. 

Quality over quantity

Quality over quantity is an adage often used to highlight the importance of having a few things that are superior in nature, versus owning many things that are inferior in their composition. Though this saying is often used when individuals may be acquiring physical items, it is also appropriate when thinking about investing. 

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 looking at the data, there is merit in this ideology. The following charts contrast the performance of the MSCI World Quality Index and MSCI Quality USA Index against their respective parent indices, as of May 2023. 

Evaluating quality companies

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.

Quality-factor investment solutions

The objective of quality factor investing is to build a portfolio of companies with these high-quality characteristics. For investors that 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 and provide Canadian investors:  

The BMO MSCI USA High Quality Index ETF (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 iShares MSCI USA Quality Factor Index ETF (XQLT) aims to capture the performance of U.S. large- and mid-capitalization companies with strong fundamentals. The investment objective of the fund is to provide long-term capital growth by replicating the MSCI USA Sector Neutral Quality Index, utilizing a simple rule-based strategy using intuitive stock selection. 

The Fidelity U.S. High Quality Index ETF (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. 

The BMO MSCI All Country World High Quality Index ETF (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.

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.