Change for ‘quality’ in US shares

With the US economic expansion getting longer and longer, nervous investors are pouring money into funds tracking the investment factor known as “quality”. It’s a category whose composition has changed.

Gone are the days when having a rock-solid balance-sheet meant you made food, sold clothes or built industrial infrastructure.

Now, technology firms are king, with chip manufacturers overrunning the list. The rules are the same -- quality denotes a high return on equity, low debt and lots of free cash flow. But the businesses that qualify have evolved.

“These tech companies have kind of grown up and they meet the criteria,” said Nick Kalivas, senior equity product strategist for Invesco’s ETF business. “They’re still more cyclical than kind of the old-school quality, so that’s a really interesting dynamic that has surfaced.”

For bubble-watchers, it’s another example of how much the market has changed since the dot-com days. Agents of volatility back then, computer and software makers now are some of the oldest and most profitable firms around. Their contribution to the S&P 500’s overall earnings has quadrupled in two decades.

ETFs that focus on quality stocks have taken in $3bn (€2.7bn), the best half-year period on record. As investors question the staying power of the bull run and economic cycle, finding companies with sound finances and profitability has become a priority.

The $1.5bn Invesco S&P 500 Quality ETF devotes more of its cash to technology stocks than any other sector. An analysis shows the fund’s tech allocation has steadily risen over the past decade.

While much of that is in software and services, semiconductor stocks also have a bigger role.

For years, there was one semiconductor company that met the criteria for inclusion in the Invesco quality fund. Now there are seven, with popular names such as Applied Materials, Intel, Qualcomm, and Texas Instruments making the cut.

But the inclusion of more cyclical stocks also means the quality factor is experiencing a “step up” in risk, Mr Kalivas said. Volatility has been friendly to quality owners in 2019. The Invesco S&P 500 Quality ETF is up 20% year-to-date, outperforming the broader S&P 500 Index, juiced by the 29% gain in technology stocks.