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ETF Specialist

Quality at a Low Cost

This ETF is a bargain for investors who want exposure to profitable companies with durable competitive advantages.

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Good companies don't always make good investments, but they may offer attractive returns relative to the market over the long term when they are trading at reasonable valuations, as they are now. Investors can get low-cost exposure to quality stocks through  iShares Edge MSCI USA Quality Factor (QUAL) (0.15% expense ratio). This exchange-traded fund tracks an index that targets large- and mid-cap U.S. stocks with high returns on equity, low debt/capital ratios, and low variability in earnings growth over the previous five years relative to their sector peers. These characteristics historically have been associated with market-beating performance, particularly in tough market environments. However, they also tend to carry higher valuations, and this fund does not impose a valuation discipline. Consequently, it lands in large-growth territory, though just barely.

The fund's sector-relative approach improves comparability but can also cause it to own some names with lower absolute quality characteristics than it otherwise would. To mitigate unintended sector bets, the fund sets its sector weightings equal to the broad market-cap-weighted MSCI USA Index's when it reconstitutes twice a year. This adjustment can increase turnover and transaction costs, though turnover here has fallen well under the Morningstar Category average. Within each sector, the fund weights its holdings according to both the strength of their quality characteristics and their market capitalization. This skews the portfolio toward stocks with durable competitive advantages, such as  Gilead Sciences (GILD),  Johnson & Johnson (JNJ), and  3M (MMM)

Alex Bryan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.