QLC: Large-Cap ETF With High-Quality Stocks
Summary QLC is an equity fund focusing on large-cap companies that are financially strong, have low valuation, and have positive performance. I compare QLC’s portfolio to four categories of large-cap ETFs, with a total of 16 ETFs being compared. There are some interesting characteristics to be found in large-cap ETFs that may be of interest in trying to choose an effective investment. A serious all-ETF portfolio needs at least one fund that focuses on large-cap U.S. equities ; arguably, large-cap companies are the mainstay of the American economy and, as a result, large-cap holdings are arguably the mainstay of any portfolio. There are currently at least 118 ETFs that focus, in one way or another, on U.S. large caps. 1 There are a variety of ways of approaching such a target: sector, size, growth, value, dividend yield, earnings, fundamentals – what have you. For its part, Northern Trust Investments ‘ FlexShares Funds recently issued a new fund: the FlexShares U.S. Quality Large Cap Index Fund (NASDAQ: QLC ). As I looked into this fund I found some interesting things that lead me to believe this ETF may have tremendous potential. The Fund The index used to model the fund’s portfolio consists of the 600 largest companies among the companies listed in the Northern Trust 1250 Index . 2 Companies are selected on the basis of three criteria: “Companies that exhibit financial strength and stability relative to the broader universe of eligible securities.” “Securities trading at lower valuations .” Stock that is displaying ” positive momentum .” 3 The weighting applied to holdings is also determined by the three criteria listed above. The fund is rebalanced/reconstituted quarterly. 4 In view of the potential frequency of reconstitution, the ER of 0.32% seems reasonable. There would seem to be the likelihood of a high turnover rate. Distribution of dividends is planned to be quarterly; distribution of capital gains is planned to be made annually. 5 In the table above, my estimate of the fund’s income includes only dividends that may be realized from its holdings as of 6 October 2015. Expenses are my estimate based on NAV (as of 6 October) and ER. The calculation of a dividend yield of 1.80% is based solely on dividend income realized by the fund that would, in principle, be paid to shareholders. 6 ,7 In the course of selecting its holdings, FlexShares manages to maintain diversity in its portfolio: (click to enlarge) Performance As is the case with any new ETF, there is little to go by in terms of the fund’s actual performance. As a substitute, I have been taking the at-the-time current portfolio for the fund and running it back for five years, to give an indication of how that particular iteration of the fund’s index has paid off. I use the weighting for each holding as it is on the day I download the fund’s holding. This may not be exactly precise , but it would be practically impossible to accurately weigh the portfolio’s holdings as they would be weighted by the index over the past five years – particularly when the weighting system is a proprietary one, as it is for QLC . The test is done with an initial $25,000 in funding. The basic performance of QLC ‘s portfolio since 1 October 2010 is reflected in the following chart: (click to enlarge) The growth of the portfolio has been fairly steady, although it does reflect the poor market conditions of the past few months. The total performance over the five years has been 103.85%. By itself, of course, the performance of the portfolio – while attractive – does not give any indication of it compares to the market in general. The following chart compares QLC ‘s portfolio to three indices: the S&P 500 , the Dow Jones Industrial Average , and the Dow Jones U.S. Large-Cap Index . 8 (click to enlarge) The performance of QLC portfolio has been quite nice when compared to the performance of the three indices; it has outperformed the S&P and the Large-Cap Index by more than 300bps , and has nearly 500bps over the DJIA. This piqued my interest. If the QLC portfolio did well compared to relevant indices, how would it look compared to other large-cap-focused ETFs? To see how the performances would compare, I performed four trials: QLC versus Large-Cap ETFs that did not use specialized focus (“straight”). QLC versus “growth” oriented large-cap ETFs. QLC versus “value” oriented large-cap ETFs. QLC versus large-cap ETFs that based selection on specialized criteria (“alternative-factor”). In each case but one I compare QLC to four other ETFs; in the case of “alternative-factor” ETFs there are only three “competitors” – most of these funds are relatively new, with less than two or three years performance to consider. 9 The four straight large-cap ETFs are: iShares Russell 1000 ETF (NYSEARCA: IWB ) iShares Morningstar Large-Cap ETF (NYSEARCA: JKD ) SPDR S&P 500 ETF (NYSEARCA: SPY ) Vanguard Large-Cap ETF (NYSEARCA: VV ) (click to enlarge) The growth-oriented ETFs consist of: iShares Russell Top 200 Growth ETF (NYSEARCA: IWY ) SPDR S&P 500 Growth ETF (NYSEARCA: SPYG ) Vanguard Growth ETF (NYSEARCA: VUG ) Vanguard Russell 1000 Growth ETF (NASDAQ: VONG ) (click to enlarge) The value large-cap ETFs include: Guggenheim S&P 500 Pure Value ETF (NYSEARCA: RPV ) iShares Russell 1000 Value ETF (NYSEARCA: IWD ) SPDR S&P 500 Value ETF (NYSEARCA: SPYV ) Vanguard S&P 500 Value ETF (NYSEARCA: VOOV ) (click to enlarge) The three alternative-factor ETFs are: First Trust Capital Strength ETF (NASDAQ: FTCS ) Guggenheim S&P 500 Equal Weight ETF (NYSEARCA: RSP ) PowerShares S&P High Quality (NYSEARCA: SPHQ ) (click to enlarge) In all four trials, only one ETF was able to rise to the occasion: Guggenheim’s RPV , in the “value” category; indeed, until this year, RPV outperformed QLC’s portfolio, and did it quite handily. While 15 ETFs may not be a very large selection of the 117 (besides QLC ) large-cap ETFs, it would seem to constitute a representative sampling. To the extent that is true, there would seem to be very little to differentiate between the various funds out there. The overall range of 74.20% to 94.74% (( RPV )) belies the fact that (A) RPV exceeds the performance of all other ETFs (other than QLC ) by at least 600bps; (B) as a group, the growth-oriented ETFs outperformed the other groupings, clustering between 88.02% (( SPYG )) and 87.15% (( IWY )) – a spread of 87bps; (C) the ETFs in each grouping tend to cluster together, within a few hundred basis points of each other. In any event, the portfolio of companies currently held by QLC far outperforms the competition. Whether this will translate into outperformance in the future remains to be seen, and past performance can never be taken as an indication of future performance. That being said, however, there is more than passing cause for some optimism here. Assessment There are a couple of observations that can be made, but let’s start with QLC : the fund seems to have a lot going for it. If the success of QLC ‘s portfolio can be attributed to the formula used by Northern Trust’s indices, this is certainly an ETF to keep an eye on. It would definitely be a fund to put on one’s watchlist – it might bear watching until it has a year behind it, to get a better idea of turnover rate, ultimate distribution yield and trading volume/liquidity; it is simply too early to get a feeling for these. I have put QLC on my watchlist as a potential replacement for the PowerShares S&P 500 Low Volatility ETF (NYSEARCA: SPLV ), or to compliment it. What seems to be something of interest (at least, to me ) is RPV . This ETF outstripped it value-based brethren, and outperformed everything but QLC ; in general, however, each grouping had a tendency to cluster. It might be worth further investigation if one is interested in finding a large-cap ETF that has proven potential . The only real question I have is why it has experienced a drop this year that has been disproportionately worse than that experienced by other large-cap funds. As for the large-cap funds in general, it looks as if the growth-oriented funds are where the best performance (as a group) are to be found. There is a fairly large gap behind the growth cluster, with the alternative-factor cluster coming in next, straight cluster third and value ETFs bringing up the rear. Except for RPV . Disclaimers This article is for informational use only. It is not intended as a recommendation or inducement to purchase or sell any financial instrument issued by or pertaining to any company or fund mentioned or described herein. All data contained herein is accurate to the best of my ability to ascertain, and is drawn from the Company’s Prospectus, Statement of Additional Information, and fact sheets. All tables, charts and graphs are produced by me using data acquired from pertinent documents; historical price data from The Wall Street Journal . Data from any other sources (if used) is cited as such. All opinions contained herein are mine unless otherwise indicated. The opinions of others that may be included are identified as such and do not necessarily reflect my own views. Before investing, readers are reminded that they are responsible for performing their own due diligence; they are also reminded that it is possible to lose part or all of their invested money. Please invest carefully. ——————– 1 A recent search on the ETF.com screener shows 118 funds when U.S. large-cap funds are searched. 2 Which, as one might expect, consists of the 1250 largest companies (by market cap) in the U.S. 3 FlexShares Trust Prospectus, FlexShares US Quality Large Cap Index Fund (QLC), p. 1. My emphasis. Prospectus is available here . A company’s “financial strength and stability” is measured by proprietary formula. A stock’s momentum is calculated regularly by the index. 4 Prospectus, p. 1. 5 Prospectus, p. 15. 6 Investors are reminded that the income distributed by an ETF is not limited to dividends it has received from its holdings. ETFs also distribute capital gains, interest received, as well as income from other instrumentalities. My estimate is typically below the sum actually paid out by the fund. 7 I am trying out some new data. In addition to my “expense margin” (how much is left after expenses are taken out of gross income), I have added “income yield” (gross income divided by NAV) and “return on NAV” (RONAV) (net income divided by NAV). All of these are intended to reflect aspects of ETF performance the way certain data reflect the performance of a company (operating margin, sales to assets, ROA, respectively). Certainly, some of this data will be more meaningful once a fund has a year’s worth of activity behind it. 8 This is in no way intended to make any claim about the performance of QLC – which didn’t exist until September, 2015; nor is it intended to make any claim about the future performance of the fund. 9 I wanted to limit the comparisons to funds with 5 years of performance history, for sake of fairness.