Quality ETFs


This is one of a series of articles discussing smart beta ETFs. Other smart beta articles you can read:



A quality ETF is a so-called "smart beta" ETF that select stocks based on one or more measures as to whether the company is a "quality" company. Although there is not necessarily a hard and fast rule, a quality company is typically considered to be a profitable company with high earnings. Some people will also imply that to be a quality company, a company must have a "good balance sheet" or be "fundamentally sound", but at StockMarketMBA.com, when we talk about the quality factor, we are referring to any ETF that selects stocks using one or more measures of the earnings of a company.

How do you measure whether a company is a profitable company? Various quality indexes are using a wide variety of methods to measure a company's earnings:

One of the challenges of evaluating smart beta ETFs is that when you dig into the details and analyze exactly what the index is doing, no two smart beta indexes ever seem to really use the same approach. Quality ETFs are the same way -- no two quality ETFs use exactly the same approach.

Academic factor research has usually concluded that quality is one of the significant factors that can lead to one company's stock outperforming the market. Fama French measured quality by looking at a company's net operating income. Hou Xue and Zhang measured quality using a company's return on equity.

There are a number of quality ETFs in our database, as shown in this table:

CategoryCount
Alternatives 1
Global Equity90
Special Security Types1
US Equity171
Total263

Most quality ETFs are relatively new, as shown by this table:

Year of InceptionCount
20004
20011
20032
20042
200516
20066
200725
20083
20091
20103
201112
20129
201317
201418
201540
201629
201725
201818
201916
20209
20217
Total263

Note that there were actually even more ETFs launched then this table shows, as we are only displaying the launch dates of ETFs still active in our database. There were more ETFs that were launched during these years that have since been closed down by their sponsor.

More and more ETFs are being launched that combine quality investing with other investment factors:

Number of Factors UsedCount
119
261
395
477
59
61
71
Total263

Here are the quality ETFs that only use quality as an investment factor (i.e. they are not multi-factor ETFs), if you want to read some examples of the approaches taken by quality ETFs:

SymbolDescriptionInception DateCategoryActions
JPXNiShares JPX-Nikkei 400 ETF10/23/2001Global EquityAnalyze
XMHQInvesco S&P MidCap Quality ETF12/01/2006US EquityAnalyze
EESWisdomTree SmallCap Earnings Fund ETF02/23/2007US Equity Analyze
EPSWisdomTree Earnings 500 Fund ETF02/23/2007US Equity Analyze
EZMWisdomTree MidCap Earnings Fund ETF02/23/2007US EquityAnalyze
EPIWisdomTree India Earnings Fund ETF02/22/2008Global EquityAnalyze
CFAVictoryShares US 500 Volatility Weighted Index ETF07/01/2014US Equity Analyze
CFOVictoryShares US 500 Enhanced Volatility Wtd ETF07/01/2014US Equity Analyze
CSFVictory US Discovery Enhanced Volatility Weighted Index ETF08/01/2014US Equity Analyze
SMCPAlphaMark Actively Managed Small Cap ETF04/21/2015US Equity Analyze
CSAVictory US Small Cap Volatility Weighted Index ETF07/08/2015US Equity Analyze
CILVictory CEMP International Volatility Weighted Index ETF08/19/2015Global Equity Analyze
HJPXiShares Currency Hedged JPX-Nikkei 400 ETF09/29/2015Global EquityAnalyze
FQALFidelity Quality Factor ETF09/12/2016US Equity Analyze
COWZPacer US Cash Cows 100 ETF 12/16/2016US Equity Analyze
CALFPacer US Small Cap Cash Cows ETF06/16/2017US Equity Analyze
ICOWPacer Developed Markets International Cash Cows 100 ETF06/16/2017Global EquityAnalyze
VFQYVanguard U.S. Quality Factor ETF02/14/2018US EquityAnalyze
BULPacer US Cash Cows Growth ETF05/02/2019US Equity Analyze
TPLETimothy Plan US Large/Mid Cap Core Enhanced ETF07/29/2021US EquityAnalyze

Do quality ETFs outperform?

In general, it is very difficult to reach conclusions about smart beta ETFs because they use so many different approaches to selecting and weighting stocks. Literally, no two smart beta ETFs seem to be the same. And they have such limited history. Quality ETFs, in particular, are using a lot of different approaches to selecting "quality" stocks.

As a stand-alone factor, the quality factor can lead to some outperformance, although it is not always dramatic. Let's look at a few examples.

EPS, the WisdomTree Earnings 500 Fund ETF, seems to be screening and weighting stocks using the classic definition of a "quality" company - companies with high core earnings. Yet it doesn't seem to make a difference, as EPS and SPY are closely correlated.


EZM, the WisdomTree MidCap Earnings Fund ETF, screens and weights stocks using core earnings, but it only includes mid cap stocks in its index. It has slightly outpeformed MDY, which tracks the S&P Mid cap 400 Index:


EES, the WisdomTree SmallCap Earnings Fund ETF, screens and weights stocks using core earnings, but it only includes smallcap stocks in its index. It has slightly outpeformed IJR, which tracks the S&P Smallcap 600 Index:


The quality factor is much more commonly used by a multi-factor ETF rather than as a stand alone factor. One thing we do at StockMarketMBA.com is give each ETF a rating for long term investors. Here are the quality ETFs that we have rated as an "editors choice", our highest rating:

SymbolDescriptionInception DateCategoryActions
PSJInvesco Dynamic Software ETF06/23/2005US EquityAnalyze
EESWisdomTree SmallCap Earnings Fund ETF02/23/2007US Equity Analyze
EZMWisdomTree MidCap Earnings Fund ETF02/23/2007US EquityAnalyze
CZAInvesco Mid-Cap Core ETF04/02/2007US EquityAnalyze
FDTFirst Trust Developed Markets Ex-US AlphaDEX ETF04/18/2011Global Equity Analyze
DVYEiShares Emerging Markets Dividend ETF02/23/2012Global EquityAnalyze
MOATMarket Vectors Morningstar Wide Moat ETF04/24/2012US EquityAnalyze
FNDCSchwab Fundamental International Small Cap Company Index ETF08/15/2013Global Equity Analyze
FNDESchwab Fundamental Emerging Markets Large Company ETF08/15/2013Global Equity Analyze
FLQEFranklin LibertyQ Emerging Markets ETF06/01/2016Global EquityAnalyze
VSDAVictoryShares Dividend Accelerator ETF04/17/2017US Equity Analyze
EEMDAAM S&P Emerging Markets High Dividend Value ETF11/28/2017Global EquityAnalyze

Conclusion

The evidence to date is not very convincing that the quality factor by itself plays a huge role in picking stocks. EES and EEM seem to indicate that picking stocks based on the company's earnings helps, particularly in the case of mid and small cap stocks, but the evidence is not overwhelming. Said another way, there hasn't been an ETF invented yet that has been able to significantly outperform the major indexes merely by screening for profitable companies.


All data is a live query from our database. The wording was last updated: 02/12/2022.

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