In an age where high-quality stocks are touted as the golden ticket to long-term outperformance, the market may be reaching saturation point with Exchange-Traded Funds (ETFs) focused on these stocks. This assertion comes as Boston-based investment firm, Jeremy Grantham’s GMO, recently announced the launch of a new ETF that will invest in high-quality stocks. With 36 other ETFs already listed in VettaFi’s quality stock category, boasting a collective $56 billion in assets under management, the question arises whether investors really need another high-quality stock-focused ETF.
The investment landscape is often a battlefield of competition and differentiation, and GMO, a firm traditionally catering to institutions and high-net-worth investors, may find it challenging to make a mark in the retail arena with their late entry. While GMO has been a long-time advocate of high-quality stocks, their new ETF enters a market already brimming with similar offerings. The challenge lies in distinguishing their new ETF from the plethora of existing ones, a task that may prove daunting in the already well-saturated market.
The Crowded Market of High-Quality Stocks ETFs: Is There Room for Another Player?
Investment firm, GMO, recently announced the launch of a new ETF focused on high-quality stocks. While high-quality stocks have a good track record for long-term outperformance over low-quality stocks, questions arise about the necessity of another ETF in an already crowded market.
GMO’s Late Entry into the Quality Stocks ETF Market
GMO, a Boston-based firm led by Jeremy Grantham, is entering a market that already boasts 36 other ETFs in the quality stock category, according to VettaFi’s ETF database. These existing ETFs collectively manage around $56 billion in assets. GMO, a firm that has long advocated for high-quality stocks, has traditionally catered to institutions and high-net-worth investors, shying away from the ETF arena. As a latecomer to a well-saturated retail market, it may struggle to distinguish its new ETF from existing ones.
Defining Quality Stocks
Quality stocks are generally understood as highly profitable stocks with consistent earnings and robust balance sheets. A comprehensive study titled "Quality Minus Junk" published in the Review of Accounting Studies in 2019 offers more insights. The researchers defined quality stocks as shares of "profitable, stable, safe" companies that distribute a significant portion of their profits as dividends. They compared the returns of two portfolios: one containing the top 10% of U.S. publicly traded stocks that scored highest in quality, and the other including the lowest 10%. The study found that from mid-1957 through mid-2023, quality stocks outperformed junk stocks by over eight annualized percentage points: 11.9% to 3.7%.
The Challenge Faced by GMO’s New ETF
Existing quality-stock funds correlate highly with the hypothetical portfolio from the "Quality Minus Junk" study. This is evident in the GMO Quality Fund Class III GQETX, which is likely to hold many of the same stocks as the newly launched ETF. The correlation coefficient between its monthly returns since 2004 and the AQR quality portfolio is an extremely high 0.95. The same is true for the two largest U.S.-equity ETFs in VettaFi’s quality stock category: The iShares MSCI USA Quality Factor ETF and the Invesco S&P 500 Quality ETF. This high correlation illustrates the marketing challenge GMO faces in gaining traction with its new ETF.
Despite the crowded market, the good news for investors is the wide choice of ETFs that capture the performance of quality stocks. Once you decide to invest in quality stocks, the specific fund or ETF you choose doesn’t seem to make a significant difference.
The question remains: does the market need another high-quality stocks ETF? While GMO’s late entry into the ETF arena presents a stiff competition, its long-standing expertise in high-quality stocks could potentially offer fresh perspectives and investment strategies. However, the firm will need to differentiate its offering in this well-saturated market to attract investors.