FQAL: Exemplary Quality, Some Growth Exposure, Yet Performance Is Unconvincing

seekingalpha05-22

FQAL is a passively managed vehicle with a strategy revolving around highly profitable U.S. bellwethers.My analysis illustrated that its portfolio has an edge over IVV when it comes to ROA, net income...

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This is not the case with FQAL. It does live up to expectations for quality with ease. In terms of exposure to cash-rich, grossly profitable companies w","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"OEX":"标普100",".SPX":"S&P 500 Index","BK4524":"宅经济概念","OEF":"标普100指数ETF-iShares","SDS":"两倍做空标普500ETF","LU0072462426.USD":"贝莱德全球配置 A2","BK4527":"明星科技股","BK4579":"人工智能","SH":"标普500反向ETF","LU0053666078.USD":"摩根大通基金-美国股票A（离岸）美元","LU0061475181.USD":"THREADNEEDLE (LUX) AMERICAN \"AU\" (USD) ACC","BK4588":"碎股","SSO":"两倍做多标普500ETF","IE00BFSS8Q28.SGD":"Janus Henderson Balanced A Inc SGD-H","BK4503":"景林资产持仓","SPHQ":"Invesco S&P 500 Quality ETF","IE00BMPRXN33.USD":"NEUBERGER BERMAN 5G CONNECTIVITY \"A\" (USD) ACC","BK4581":"高盛持仓","BK4504":"桥水持仓","SPXU":"三倍做空标普500ETF","LU0234572021.USD":"高盛美国核心股票组合Acc","LU0080751232.USD":"富达环球多元动力基金A","LU0061474705.USD":"THREADNEEDLE (LUX) GLOBAL DYNAMIC REAL RETURN \"AU\" (USD) ACC","LU0276348264.USD":"THREADNEEDLE (LUX) GLOBAL DYNAMIC REAL RETURN\"AUP\" (USD) INC","FQAL":"Fidelity Quality Factor ETF","LU0082616367.USD":"摩根大通美国科技A（dist）","IE00B7KXQ091.USD":"Janus Henderson Balanced A Inc USD","IE00BWXC8680.SGD":"PINEBRIDGE US LARGE CAP RESEARCH ENHANCED \"A5\" (SGD) ACC","IVV":"标普500指数ETF","LU0234570918.USD":"高盛全球核心股票组合Acc Close","LU0109391861.USD":"富兰克林美国机遇基金A Acc","VOO":"Vanguard标普500ETF","SPY":"标普500ETF","IE00BMPRXR70.SGD":"Neuberger Berman 5G Connectivity A Acc SGD-H","BK4592":"伊斯兰概念","BK4532":"文艺复兴科技持仓","JQUA":"JPMorgan US Quality Factor ETF","LU0238689110.USD":"贝莱德环球动力股票基金","IE00B1BXHZ80.USD":"Legg Mason ClearBridge - US Appreciation A Acc USD","UPRO":"三倍做多标普500ETF","LU0308772762.SGD":"Blackrock Global Allocation A2 SGD-H","IE00B19Z9505.USD":"美盛-美国大盘成长股A Acc","QUAL":"iShares MSCI USA Quality Factor ETF","BK4220":"综合零售","LU0130102774.USD":"Natixis Harris Associates US Equity RA USD","FDN":"First Trust Dow Jones Internet I","IE00BFSS7M15.SGD":"Janus Henderson Balanced A Acc SGD-H","IE0009356076.USD":"JANUS HENDERSON GLOBAL TECHNOLOGY AND INNOVATION \"A2\" (USD) ACC"},"translate_title":"FQAL：模范质量，一些增长风险，但表现不令人信服","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"SPHQ":1,"QUAL":1,"JQUA":1,"FQAL":1,"FDN":0.9,"VOO":0.87,"SPY":0.7,"OEF":0.6,"OEX":0.6,"SDS":0.6,"SH":0.6,"SPXU":0.6,"SSO":0.6,"UPRO":0.6,".SPX":0.6,"ESmain":0.6,"IVV":0.6},"content_text":"FQAL is a passively managed vehicle with a strategy revolving around highly profitable U.S. bellwethers.My analysis illustrated that its portfolio has an edge over IVV when it comes to ROA, net income margin, FCF margin, and other quality parameters.Its value and growth characteristics are mostly on par with those of IVV.Alas, FQAL's returns are still unconvincing, as it underperformed IVV and a few peers in the past, so I would opt for a Hold rating again in spite of its excellent quality characteristics.   Rouzes Today, I would like to present an overdue update on the Fidelity Quality Factor ETF (NYSEARCA:FQAL), a passively managed vehicle with a strategy revolving around highly profitable U.S. bellwethers. The previous time I assessed FQAL was in March 2022, when I opted for a more conservative Hold rating, owing chiefly to its unappealing past performance, while the excessive valuation of its portfolio, which was in turn the consequence of the interconnected size and profitability premia, something that was clearly risky in a high interest rate environment as the Fed had just started rate increases back then in order to suppress inflationary forces, also contributed to my skepticism. Today's update is necessary principally because FQAL's portfolio has been significantly recalibrated since the previous note, i.e., about 27% of the holdings have been replaced, as per my calculations. In this regard, factor exposures have most likely changed as a consequence, welcoming a reassessment for a possible rating upgrade. As to the structure I would prefer this time, it is based on the questions investors who are considering buying into FQAL might ask, including those on the factor front, performance intricacies, and its alpha potential or lack thereof. But before we proceed to all these, it is worth recapping the strategy. FQAL is managed passively, precisely like the Invesco S&P 500 Quality ETF (SPHQ), the iShares MSCI USA Quality Factor ETF (QUAL), and the JPMorgan U.S. Quality Factor ETF (JQUA). The main ingredient of the strategy is the Fidelity U.S. Quality Factor Index, which is rebalanced twice a year. As we can deduce from the methodology document available on the Fidelity website, the cornerstone of the index is the composite factor score, which is calculated separately for the Banks industry and for the remaining candidates. For the former, it is twofold, with Return on Equity and Debt/Assets weighted equally. For the latter, it is tripartite: FCF margin, Return on Invested Capital, and FCF stability. The selection universe consists of the 1,000 most expensive U.S. stocks. Importantly, the index adheres to the sector neutrality principle. Is FQAL living up to expectations for quality? Perhaps the worst thing about ETF factor investing is that funds frequently do not deliver what they promise. This is not the case with FQAL. It does live up to expectations for quality with ease. In terms of exposure to cash-rich, grossly profitable companies with solid returns on capital, it clearly beats IVV. This is not only because among the 125 common stocks it had in its portfolio as of May 17, there were no loss-making companies, while IVV had about 2.5% allocated to such names. There are other, much more important, considerations to be detailed below. First, my calculations show that FQAL's weighted-average net income margin is meaningfully stronger at almost 27%, while IVV had 20.5%. This difference is driven by the fact that all 11 GICS sectors represented in the ETF have higher average NI margins than in IVV, with financials, IT, and energy being especially strong as they sport average margins of 36.4%, 31.2%, and 26.6%, respectively (19.1%, 17.6%, and 16.8% in IVV), as the table below illustrates. Holdings as of May 17. Financial data as of May 20 (Calculated by the author using data from Seeking Alpha, FQAL, and IVV) Second, net income is certainly just the tip of the iceberg. My dear readers may justly remark here that net earnings are unreliable as they can be manipulated easily. This argument has merit. In this regard, we should look at other parameters that are less vulnerable to that. The EBITDA margin is a nice option to use, though it has limitations as it is inapplicable to most financial sector players (i.e., banks). So here, FQAL again has an edge, offering much higher average EBITDA margins, especially in the case of IT and health care. Third, my calculations show that the median levered FCF margin is 17.6% for FQAL and only 10.5% for IVV. Fourth, capital efficiency-wise, FQAL is once again ahead. I would prefer elaborating on that using the adjusted Return on Equity and Return on Assets (as-is). ROE required adjustments as both portfolios have exposure to companies with overinflated figures, chiefly influenced by burdensome debt, as well as to firms with negative ROE that were also removed. After deleting all the unrealistic excesses, we see that IVV's adjusted ROE is close to 25%, while FQAL is offering 30.3%. In terms of ROA, FQAL also bested the S&P 500 ETF, with 16.8% vs. 12.8%, with the IT sector being the primary contributor (an average ROA of 21.8% vs. 11.1%). Fifth, another ingredient that we certainly should mention is the share of companies with a B- Quant Profitability rating or higher. IVV had about 94.3% allocated to such names as of May 20, while FQAL invested about 98.7% in them. Moreover, there were no companies with a Profitability rating of D+ or lower in the FQAL portfolio (3.2% in IVV). Is FQAL offering a compelling valuation story? An issue that is embedded in FQAL's strategy is that it will be constantly overweight in stocks that have meaningful size and quality premia. So, a compelling valuation story is obviously not to be expected.       Metric FQAL IVV   Market Cap $785,752 million $861,280 million   Trillion-dollar companies' weight 25.56% 28.7%   EY 4.16% 3.74%   Adjusted EY N/A 3.87%   P/S 9.29 7.81   EV/EBITDA 23.55 22.76   Quant Valuation B- or higher 6.45% 7.73%   Quant Valuation D+ or lower 80.41% 81.64%   Click to enlarge Calculated by the author using data from Seeking Alpha, FQAL, and IVV. Financial data as of May 20 As we can tell from the table above, FQAL has a smaller weighted-average market cap, mostly as a consequence of its smaller exposure to the trillion-dollar echelon (it ignored Amazon (AMZN)). Next, the fund does have a slightly stronger as-is earnings yield, with one of the reasons being its exposure to companies with solid NI margins discussed above. There is no adjusted figure here as unprofitable firms are absent. However, it looks more expensive on a Price/Sales and EV/EBITDA basis, and its allocation to companies with a D+ Valuation rating or lower is larger. That is to say, valuation-wise, FQAL is mostly close to the S&P 500, and investors seeking a better calibrated value & quality mix should look elsewhere. Is the dosage of growth factor in FQAL's equity mix sufficient? I would say that FQAL's exposure to growthier, longer-duration equities that are currently in the limelight is fairly healthy. But precisely like in the case of the value factor, as the data below illustrate, the allocation is close to that of IVV.       Metric FQAL IVV   EPS Fwd 16.38% 14.91%   Revenue Fwd 10.97% 10.12%   EBITDA Fwd 16.36% 16.26%   Quant Growth B- or higher 57.62% 57.51%   Quant Growth D+ or lower 18.87% 19.14%   Click to enlarge Calculated by the author using data from Seeking Alpha, FQAL, and IVV Does FQAL have alpha potential? While the ETF has a factor mix that I appreciate, I doubt that it has alpha potential. The main reason for skepticism is its past performance. Incepted in September 2016, FQAL was incapable of delivering an annualized return stronger than that of IVV, QUAL, or SPHQ.    Metric FQAL IVV QUAL SPHQ   Start Balance $10,000 $10,000 $10,000 $10,000   End Balance $24,468 $26,516 $26,266 $26,082   CAGR 12.52% 13.72% 13.58% 13.48%   Standard Deviation 16.13% 16.36% 16.93% 15.63%   Best Year 31.30% 31.25% 33.89% 33.29%   Worst Year -20.03% -18.16% -20.49% -15.77%   Maximum Drawdown -25.42% -23.93% -27.78% -24.33%   Sharpe Ratio 0.7 0.76 0.73 0.77   Sortino Ratio 1.06 1.16 1.12 1.2   Click to enlarge Data from Portfolio Visualizer. The period is October 2016–April 2024 Also, compared to JQUA, which was incepted in November 2017, it also looks rather bleak.    Metric FQAL JQUA   Start Balance $10,000 $10,000   End Balance $19,503 $22,286   CAGR 10.97% 13.30%   Standard Deviation 17.39% 16.71%   Best Year 31.30% 28.67%   Worst Year -20.03% -13.46%   Maximum Drawdown -25.42% -22.15%   Sharpe Ratio 0.57 0.71   Sortino Ratio 0.86 1.12   Click to enlarge Data from Portfolio Visualizer. The period is December 2017–April 2024 Final thoughts In my previous note that was presented in March 2022, I called the Fidelity Quality Factor ETF \"a suboptimal choice for quality factor exposure.\" This was not because the ETF was incapable of selecting highly profitable names. The issue back then was its performance as well as its uncomfortable valuation, as a new, growth-averse market regime was developing. But as the conditions changed, should my mostly lukewarm tone be abandoned?  Alas, I see the facts that hinder me from becoming a FQAL bull, despite its portfolio having clearly impressive quality. The key reason here is that its performance is still hardly convincing. That is to say, I am skeptical about this vehicle beating the S&P 500 (and respective ETFs) consistently, even despite the fact that its expense ratio was substantially downsized in November last year, from 29 bps to 15 bps. So the Hold rating remains valid.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2437265723"}