Why investing in quality is crucial in the current market

There's a long history of investors getting caught out after trying to be too smart, but investing in quality names is a smart move in any market environment

Why investing in quality is crucial in the current market

Investing doesn’t need to be complicated – in fact, it should be pretty simple. There’s a long history of investors getting caught out after trying to be too smart; trying to find opportunities that don’t really exist.

The reality is that investing in quality names - market leading companies with a track record of outperformance - is a smart move in any market environment. In time as such as these, with volatility and geopolitical uncertainty playing an increasingly central role, investing in quality isn’t just a smart move – it’s a crucial one.

“Quality-based investing is identifying market-leading companies with sustainable competitive advantages, which tend to outperform over time,” says Chris Heakes, Director, Portfolio Manager, Exchange Traded Funds, BMO GAM. “Having quality companies in your portfolio tends to give you an edge relative to someone without any quality screens in their portfolio. Our Quality ETFs begin with the broad market-cap portfolio, but they are tilted towards quality, with the aim to improve performance over time.”

When selecting companies for its portfolio of Quality ETFs, BMO uses MSCI’s quality index methodology, which ensures that quality screenings are implemented systematically and in a disciplined way. MSCI uses three metrics: high return on equity, stable earnings and low-debt equity. Each metric on its own is not necessarily an indicator of a quality company, but the three combined provide an accurate assessment.

The portfolio construction methodology aims not only to capture the performance of high-quality companies but also to ensure reasonably high-trading liquidity and moderate security turnover while staying cost-effective. Security selection relies on the determination of the three quality metrics, while weighting is based on a combination of the security’s quality scores and market capitalization. Quality indices are rebalanced semi-annually.

As a result, the BMO MSCI All Country World High Quality Index ETF (ZGQ), for instance, has performed better than the broad index over the past six months, as have all Quality ETFs, according to Heakes. From a geographical perspective, BMO GAM’s Quality ETFs portfolio favours the US.

“The US economy is dense, it’s been the global engine of the past three, four years and probably doing the best of any economies in the world,” Heakes says. “Also, a lot of these market-leading companies in the US have operations that go global. On a sector basis, the portfolio tended to overweight IT and underweight financials. IT companies have exhibited some of the best profitability and lowest debt-equity ratios amongst all global stocks; whereas financials with their higher debt load have tended to not make it through the portfolio’s screens.”

Given the current economic and political backdrops, Heakes believes that quality-based investing is more important than ever.

“We’re certainly getting towards the end of the cycle, however solid growth and low unemployment remains in place. In terms of positioning equities, the cautious tilt is wanted, but I think you still want to be invested in equities to take advantage of the last stage of the equity rally,” Heakes says. “Quality investing gives exposure to equity growth, but also defensive positioning should economic conditions change. Quality investing helps get investors into more stable, profitable investments that should help protect value in an equity sell-off.”


The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.
Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.
BMO ETFs are managed by BMO Asset Management Inc., which is an investment fund manager and a portfolio manager, and a separate legal entity from Bank of Montreal.
Commissions, management fees and expenses all may be associated with investments in exchange traded funds. Please read the ETF Facts or prospectus before investing. Exchange traded funds are not guaranteed, their values change frequently and past performance may not be repeated. For a summary of the risks of an investment in the BMO ETFs, please see the specific risks set out in the prospectus. BMO ETFs and ETF series trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.

®/™Registered trade-marks/trade-mark of Bank of Montreal, used under licence.