A high-quality ETF under the radar

  • Fidelity Quality Factor ETF (FQAL) earns a five-star CFRA rating based on its strong performance, attractive holdings, and moderate expense ratio.
  • The fund takes a sector neutral approach focusing on free cash flow and return on invested capital. Eight of its top 10 recent stocks are undervalued by CFRA equity analysts.
  • The CFRA expects FQAL to outperform its US equity ETF peers over the next nine months.

The CFRA Focus ETF for January is the Fidelity Quality Factor ETF (FQAL). The fund obtains a five-star rating from the CFRA, based on a combination of its risk, return and cost attributes and using portfolio-level and fund-specific analysis. Rather than relying solely on past performance to star rating U.S. equity ETFs, the CFRA also offers a forward-looking view of the stocks within and the costs of the fund. In contrast, the ETF is rated four stars by Morningstar, which is based solely on its past performance.

FQAL’s proprietary index takes a sector neutral approach and focuses on the free cash flow margin to assess whether or not a company has high earnings quality, on the stability of free cash flow to measure consistency and on return on invested capital to assess profitability. This is different from some other quality oriented ETFs which may be overweight in certain sectors and / or focus on leverage. Given the likely slower earnings growth across the industry in 2022, we believe investors will benefit from a diverse basket of higher quality companies.

In the information technology sector (29% of assets), the fund owns Apple (AAPL), Microsoft (MSFT) and NVIDIA (NVDA), all of which are recommended by CFRA Buy or Strong Buy. Healthcare (13%) and consumer discretionary (12%) positions include Pfizer recommended by CFRA Strong Buy (PFE) and UnitedHealth Group (UNH), as well as Lowe’s (LOW) and McDonald’s (MCD) recommended by CFRA Buy . Overall, eight of the fund’s top 10 holdings were rated attractive by CFRA equity fundamental analysts. Meanwhile, nine of the top 10 ETF holdings achieved good earnings quality scores according to CFRA’s forensic analysis.

The index behind FQAL is rebalanced every six months, with the next taking place in mid-February. The recent annual fund turnover rate of 35% confirms that positions can change. For example, the fund added Applied Materials (AMAT) and Merck (MRK) during the August rebalance, while removing Edward Lifesciences (EW) and FLEETCOR Technologies (FLT).

FQAL is an under-the-radar quality ETF that performed well in 2021. FQAL rose 32% in 2021, outperforming the S&P 500 Index’s 29% as well as the returns of some more popular smart-beta ETF peers. The 25 billion dollars and five stars CFRA IShares Edge MSCI USA Quality Factor ETF (QUAL) and the $ 3.6 billion and five stars Invesco S&P 500 Quality ETF (SPHQ) grew 27% and 28%, respectively, in 2021. FQAL ended 2021 with $ 260 million in assets, despite outperforming both QUAL and SPHQ over the past five years (18.2% versus 18.1% and 17.3%, respectively). Although FQAL’s expense ratio of 0.29% is slightly higher than its peers, we believe investors have benefited and will likely continue to benefit in 2022. FQAL has higher reward potential and incurs less risks than its high-quality peers and the broader category of US stocks according to the CFRA star. – rating process. We believe investors should be more aware of FQAL and the larger smart-beta suite that Fidelity offers.

Todd Rosenbluth is Director of ETF and Mutual Fund Research at CFRA.

For more news, information, and strategies, see ETF Trends.

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