Exploring ETF Opportunities and a Flight to Quality

Written by: Nick Kalivas | Invesco

Investors seeking to manage volatility may want to consider strategies that provide access to Quality companies that show signs of financial strength

History has shown that long-term investment returns are achieved by remaining invested in the market; in fact, missing just a few days can determine whether investors ultimately achieve their long-term investment objectives.

Yet as coronavirus-related volatility continues to roil markets, investors are naturally concerned by the undetermined length of the economic shutdown, the potential for relapse, and the long-term outcomes on investment portfolios. As a result, they may be looking for exposures that can help mitigate risk while also allowing them to participate in the market’s eventual recovery.

I believe that recent market declines give investors an opportunity to reposition their portfolios by upgrading to ETFs that can help manage volatility and mitigate downside risk, as well as provide diversified access to those companies with fundamental strength. Investors seeking to manage volatility may want to consider strategies that provide access to companies with lower volatility, or strategies that help them access Quality companies.

What is a Quality company?

What constitutes a “Quality company,” anyway? Simply put, a quality company is often characterized as one with strong measures of financial health, including strong cash flow, low leverage, and a high return on equity with a solid balance sheet.

By this definition, the Quality factor is more concerned with a company’s financial position rather than earnings growth or valuation.

Why consider Quality now?

During periods of economic turbulence and credit stress, investors may look to companies demonstrating financial strength. Amid lingering uncertainty over the speed and strength of the post-pandemic economic recovery, Quality companies are naturally better-positioned to handle economic adversity, compared to companies that have poor cash generation and high leverage.

How does Quality perform in a bear market?

Quality may equal opportunity for investors. Quality has tended to show outperformance against the S&P 500 Index when the S&P 500 is declining, while lagging slightly when the S&P 500 is rising. 1 Therefore, Quality companies are more defensive in nature, but still allow investors to participate in periods of economic strength.

Several Quality companies have made the news in recent weeks, including two held by Invesco S&P 500® Quality ETF (SPHQ): Johnson & Johnson (5.78%2) and Proctor & Gamble (4.72%2), which reported strong Q1 profits and dividend increases. Although P&G’s results were supported by COVID-19 buying patterns, the company indicated it would pay over $7.5 billion in dividends and buyback between $7 to $8 billion in 2020, highlighting its financial strength and robust cash flow generation.3

SPHQ also holds Gilead Science, Inc. (2.012), which is thought to have developed a breakthrough COVID-19 treatment.4 Three brokers recently raised the possibility of Costco, another holding (2.132), paying a special dividend. The ability of a company to pay a special dividend is a sign of operational strength and robust cash flow generation.

As investors look to mitigate the risks arising from an uncertain earnings season, Quality companies could be a powerful addition to their portfolios.

How can investors access Quality companies?

The Invesco S&P Quality ETF suite offers investors exposure to equities with solid fundamentals, including a healthy balance sheet, higher profitability potential, strong operating cashflows, lower leverage, and consistent earnings quality. By investing in the highest quality quintile of its parent index, our Quality suite provides access to those firms with the requisite discipline and financial strength to weather the market’s storms while also capitalizing in periods of market strength.

1 Source: Bloomberg, L.P. as of April 24, 2020

2 Holdings data as of April 28, 2020

3 Source: Bloomberg, L.P. as of April 17, 2020

4 Source: Bloomberg, L.P. as of April 14 and 17, 2020

Related: The Disconnect Between the Stock Market and the Economy