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:
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:
| Category | Count |
|---|---|
| Alternatives | 1 |
| Global Equity | 90 |
| Special Security Types | 1 |
| US Equity | 171 |
| Total | 263 |
| Year of Inception | Count |
|---|---|
| 2000 | 4 |
| 2001 | 1 |
| 2003 | 2 |
| 2004 | 2 |
| 2005 | 16 |
| 2006 | 6 |
| 2007 | 25 |
| 2008 | 3 |
| 2009 | 1 |
| 2010 | 3 |
| 2011 | 12 |
| 2012 | 9 |
| 2013 | 17 |
| 2014 | 18 |
| 2015 | 40 |
| 2016 | 29 |
| 2017 | 25 |
| 2018 | 18 |
| 2019 | 16 |
| 2020 | 9 |
| 2021 | 7 |
| Total | 263 |
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 Used | Count |
|---|---|
| 1 | 19 |
| 2 | 61 |
| 3 | 95 |
| 4 | 77 |
| 5 | 9 |
| 6 | 1 |
| 7 | 1 |
| Total | 263 |
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:
| Symbol | Description | Inception Date | Category |
|---|---|---|---|
| JPXN | iShares JPX-Nikkei 400 ETF | 10/23/2001 | Global Equity |
| XMHQ | Invesco S&P MidCap Quality ETF | 12/01/2006 | US Equity |
| EES | WisdomTree SmallCap Earnings Fund ETF | 02/23/2007 | US Equity |
| EPS | WisdomTree Earnings 500 Fund ETF | 02/23/2007 | US Equity |
| EZM | WisdomTree MidCap Earnings Fund ETF | 02/23/2007 | US Equity |
| EPI | WisdomTree India Earnings Fund ETF | 02/22/2008 | Global Equity |
| CFO | VictoryShares US 500 Enhanced Volatility Wtd ETF | 07/01/2014 | US Equity |
| CFA | VictoryShares US 500 Volatility Weighted Index ETF | 07/01/2014 | US Equity |
| CSF | Victory US Discovery Enhanced Volatility Weighted Index ETF | 08/01/2014 | US Equity |
| SMCP | AlphaMark Actively Managed Small Cap ETF | 04/21/2015 | US Equity |
| CSA | Victory US Small Cap Volatility Weighted Index ETF | 07/08/2015 | US Equity |
| CIL | Victory CEMP International Volatility Weighted Index ETF | 08/19/2015 | Global Equity |
| HJPX | iShares Currency Hedged JPX-Nikkei 400 ETF | 09/29/2015 | Global Equity |
| FQAL | Fidelity Quality Factor ETF | 09/12/2016 | US Equity |
| COWZ | Pacer US Cash Cows 100 ETF | 12/16/2016 | US Equity |
| CALF | Pacer US Small Cap Cash Cows ETF | 06/16/2017 | US Equity |
| ICOW | Pacer Developed Markets International Cash Cows 100 ETF | 06/16/2017 | Global Equity |
| VFQY | Vanguard U.S. Quality Factor ETF | 02/14/2018 | US Equity |
| BUL | Pacer US Cash Cows Growth ETF | 05/02/2019 | US Equity |
| TPLE | Timothy Plan US Large/Mid Cap Core Enhanced ETF | 07/29/2021 | US Equity |
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:
| Symbol | Description | Inception Date | Category |
|---|---|---|---|
| PSJ | Invesco Dynamic Software ETF | 06/23/2005 | US Equity |
| EES | WisdomTree SmallCap Earnings Fund ETF | 02/23/2007 | US Equity |
| EZM | WisdomTree MidCap Earnings Fund ETF | 02/23/2007 | US Equity |
| CZA | Invesco Mid-Cap Core ETF | 04/02/2007 | US Equity |
| FDT | First Trust Developed Markets Ex-US AlphaDEX ETF | 04/18/2011 | Global Equity |
| DVYE | iShares Emerging Markets Dividend ETF | 02/23/2012 | Global Equity |
| MOAT | Market Vectors Morningstar Wide Moat ETF | 04/24/2012 | US Equity |
| FNDC | Schwab Fundamental International Small Cap Company Index ETF | 08/15/2013 | Global Equity |
| FNDE | Schwab Fundamental Emerging Markets Large Company ETF | 08/15/2013 | Global Equity |
| FLQE | Franklin LibertyQ Emerging Markets ETF | 06/01/2016 | Global Equity |
| VSDA | VictoryShares Dividend Accelerator ETF | 04/17/2017 | US Equity |
| EEMD | AAM S&P Emerging Markets High Dividend Value ETF | 11/28/2017 | Global Equity |
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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