Quality Stocks Lure Record Cash From ETF Buyers Playing Defense

(Bloomberg) -- Caution rules for investors in exchange-traded funds, despite the S&P 500 Index’s strongest nine-day rally since 2011.

More than $1.3 billion flowed into the iShares Edge MSCI USA Quality Factor ETF, or QUAL, on Tuesday, data compiled by Bloomberg show. That was a record for the fund, which focuses on companies supposed to fare better in downturns, and double the amount added to any other U.S.-listed ETF.

Quality stocks seemed an almost unanimous favorite heading into the year, with firms from State Street Global Advisors to USAA Asset Management and Charles Schwab Investment Management endorsing the strategy. With slower economic growth and increased market volatility expected, investors want large companies with healthy balance sheets and cash flow that can better weather any storm.

“When the market becomes choppier, investors look for a better built boat,” said Todd Rosenbluth, director of ETF research at CFRA Research. “They want to go where there’s stability and consistency of earnings, companies that have limited leverage, and QUAL is designed to do that.”

Since the pre-holiday sell-off on Dec. 24, the S&P 500 has increased more than 10 percent, thanks to more dovish rhetoric from Federal Reserve Chairman Jerome Powell, better-than-expected jobs data and three days of trade discussions between the U.S. and China. Volatility however remains above last year’s average and the two-week rally will soon confront the reality of earnings season.

That’s augmented the appeal of more stable companies. Quality was one of the worst-performing factors of 2018, with QUAL -- the largest ETF in that category -- falling 7.4 percent, more than other defensive strategies like low volatility, for example. Shares have increased 10 percent from their Dec. 24 low, and returns could rebound further as investors speculate over whether or not the end of the longest bull market on record is near.

“It’s true certainly that later in a bear market or later in a cycle, larger caps and quality tend to do better,” said Aaron Clark, a portfolio manager at Boston-based GW&K Investment Management, which oversees $36 billion. “That’s kind of the playbook.”

But QUAL isn’t the only defensive fund to find a bid this week. Its gain looks to be part of a larger shift -- likely by a big retail-oriented investment adviser, according to Josh Lukeman, head of ETF market making for the Americas at Credit Suisse Group AG. Cash also flowed into funds focused on consumer staples, health care and debt, while exiting financials, technology, consumer-discretionary and energy stocks, he said.

For example, the $5.8 billion iShares Short Maturity Bond ETF, or NEAR, added $62 million on Tuesday, its largest inflow in more than a month. NEAR tracks a portfolio of short-term, investment-grade bonds, and attracted a heap of cash last year as investors sought safety in debt instruments with less duration risk.

“We’ve gone from accelerated growth and synchronized growth to now deceleration,” GW&K’s Clark said. “Layer on top of that any sort of political and trade uncertainty, and you’ve got a recipe for some volatility. I just don’t think we’re fully out of the woods yet.”

--With assistance from Tom Lagerman.

To contact the reporters on this story: Reade Pickert in New York at epickert@bloomberg.net;Carolina Wilson in New York City at cwilson166@bloomberg.net;Sarah Ponczek in New York at sponczek2@bloomberg.net

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Rachel Evans, Dave Liedtka

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