JQUA: A diversified, quality ETF with low volatility

Macroeconomic factors remain top of mind for investors, as a sluggish growth scenario and uncertainties about the interest rate path are tempered by a generally positive long-term outlook, supported by a strong labor market and easing inflationary pressures.

This context underscores the attractiveness of investment alternatives with a bias toward more stable and profitable companies in the market, including funds with a selective approach to these companies, such as the JPMorgan US Quality Factor ETF (NYSEARCA: JQUA), which uses a diversified allocation strategy that favors companies with higher profitability and earnings quality.

This fund has delivered consistent returns, marginally above the Russell 1000 index and most quality ETFs, and with relatively lower volatility, making it suitable for investors seeking exposure to the general market while reducing risk. decline.

ETF Description and Highlights

JQUA is an exchange traded fund that offers exposure to US mid-cap and large-cap companies with superior quality characteristics, tracking the investment performance of the JPMorgan US-Parent Quality Factor Index.

This index, managed by FTSE, selects stocks from the constituents of the Russell 1000 index, which comprises the 1,000 largest US companies by market capitalization, generally corresponding to the universe of mid- and large-cap companies.

The index provider adopts a proprietary rules-based selection process, applying a quality factor to identify high-quality companies as measured by profitability, earnings quality and creditworthiness. Stock sectors such as financials and technology are weighted in the index according to their market capitalization, with individual stocks also weighted within each sector to ensure diversification.

As of September 10, 2024, JQUA had $4.7 billion in AUM invested in 275 companies with an average market capitalization of $109.9 billion, primarily in large and mega caps, representing approximately 63% of total holdings, while mid-caps correspond to 29% and small-caps 6.9%. Compared to the Russell 1000 Index, the fund manager’s preferred benchmark, and represented in this analysis by the iShares Russell 1000 ETF (IWB), JQUA is slightly more skewed toward smaller-cap companies because the account’s small- and mid-cap stocks . for approximately 24% of the index.

JQUA’s top ten holdings are Berkshire Hathaway (2.2%), Apple (2.0%), Meta Platforms (1.9%), Microsoft (1.8%), Visa (1.8%), Exxon Mobil (1.7%), Johnson & Johnson (1.6%) ), Procter & Gamble (1.6%), Mastercard (1.6%) and Alphabet (1.6%), representing a balanced approach across sectors such as financial services, technology, communications services and healthcare, rather than an individual market capitalization. weighted allocation commonly found in many funds.

Below is a table comparing JQUA to a similar group of quality large-cap ETFs. QUAL and SPHQ are weighted based on quality metrics, while FQAL maintains a broader market sector exposure. TTAC has a diversified allocation by market capitalization. The last, ROE, follows an equal weight investment approach.

In terms of sector allocation, JQUA’s largest allocation is to the technology sector with 33.2% of total holdings, followed by financial services with 14.2%, healthcare with 12.0%, consumer discretionary with 10 .8%, industry with 8.3%, consumer goods with 6.5%. %, communication services by 5.7%, energy by 3.7%, real estate by 2.7%, basic materials by 1.6% and utilities by 1.4%. JQUA has broadly similar sector exposure to the Russell 1000 Index, as JQUA’s parent index provider aims to maintain market capitalization-weighted sector exposure. Discrepancies, such as JQUA’s overweight allocation to technology, are likely a byproduct of recent gains in sector holdings ahead of the next rebalance.

Despite this, there has been notable divergence in megacap stock allocations, as Microsoft, Apple and Nvidia account for at least 5% each in the Russell 1000 index, while accounting for less than 2% of JQUA. This is offset by overweight exposure to a number of large second-tier caps such as Berkshire Hathaway, Visa, P&G and tech names such as AMD, Salesforce and Oracle.

Compared to the pool of quality ETFs, JQUA is slightly overweight financials, real estate and consumer discretionary, but with lower exposure to consumer staples, reflecting JQUA’s allocation to Berkshire Hathaway, Visa, Mastercard and industries such as retail and specialty retail.

Valuation in line with the wider market

JQUA’s price-to-earnings ratio of 22.4x is similar to the Russell 1000 and its peer group of quality ETFs, such as underweight positions in Microsoft (31.4x), Apple (32.9x) and no exposure to Amazon ( 38.0x) or Tesla ( 95.4x) are offset by a lighter allocation to Costco (55.5x), as well as other tech companies like ServiceNow (62.3x) and Palo Alto Networks (55.4x).

Paradoxically, JQUA’s portfolio profitability measures, such as EBITDA margin and return on equity, are about four percentage points lower than the Russell 1000 index, in part due to JQUA’s lower allocation to three profitable names: Microsoft, Apple and Nvidia.

Solid returns, lower volatility

JQUA’s total returns largely met expectations for a quality fund, with limited losses in negative equity market years such as 2018 and 2022 and a slight outperformance against the broader market as measured by the Russell Index 1000, in the last 3- and 5-year periods. JQUA also did slightly better than the average of quality ETFs, with the second best performance just behind SPHQ. Its volatility was lower than both the Russell and similar quality ETFs, helped by its diversified allocation, where its main holding, Berkshire Hathaway, weighs just 2.2% of the fund.

While JQUA has delivered solid performance, I find its diversification strategy somewhat tight. More exposure to companies like Microsoft or Apple would likely help long-term performance, rather than just 1.8% and 2.0% respectively. However, the overall outcome of this strategy may still be positive for the fund, especially in the short term, as the macroeconomic outlook and political scenario are expected to keep volatility at high levels, especially in a US election year, with uncertainties regarding the way to reduce the interest rate.

That said, I view quality funds, and JQUA in particular, as an important component of a diversified portfolio given the overall constructive long-term economic outlook, along with some challenges in the coming quarters due to the slowdown in economic activity. and earnings growth.