Exchange-traded funds are typically used to track indices like the FTSE 100 but there is a burgeoning list of products which look to tap different themes and even investment styles.

This universe was recently added to with the launch of some new ETFs which look to track quality stocks.

WHAT ARE THE NEW PRODUCTS?

State Street Global Advisors is the name behind these two fresh additions –  SPDR S&P Developed Quality Aristocrats ETF (QDEV) and SPDR S&P 500 Quality Aristocrats UCITS ETF (QUS5).

Investors may be familiar with the dividend aristocrat indices and the ETF SPDR S&P UK Dividend Aristocrats (UKDV). These recently launched quality ETFs track two separate indices which comprise of high-quality companies with a proven history of generating FCF (free cash flow).

The SPDR S&P Developed Quality Aristocrats ETF tracks the S&P Developed Quality FCF Aristocrats Index, which selects its constituents from a global universe of large and mid-cap stocks whereas the SPDR S&P 500 Quality Aristocrats ETF tracks the S&P 500 Quality FCF Aristocrats Index, which selects constituents from the US large-cap S&P 500 universe. They exclude companies from real estate, banks, insurance, specialised finance sectors.

Both underlying indices are rebalanced semi-annually in April and October and screen for companies that have generated FCF for 10 years in a row. From these screened universes, each index selects the top 100 companies with the highest FCF margin and FCF return on invested capital.

By prioritising FCF the ETFs aim to deliver exposure to companies with a disciplined approach to their finances. Remember, clever accounting can paint profit and earnings metrics in a flattering light but cash flow is much more difficult to manipulate.

There is some overlap with the companies in the S&P Quality FCF Aristocrats and the S&P Developed Quality FCF Aristocrats indices with a mix of US tech giants including Apple (AAPL:NASDAQ) and Broadcom (AVGO:NASDAQ), Nvidia (NVDA:NASDAQ), Microsoft (MSFT:NASDAQ), Meta Platforms (META:NASDAQ) and global financial giants Visa (V:NYSE) and Mastercard (MA:NYSE) and healthcare groups Roche (ROG:SWX)) and Novo Nordisk (NVO:NYSE).

HOW HAVE THE QUALITY ARISTOCRATS ETFS PERFORMED?

Because the indices underlying these products is new there isn’t an extensive track record of performance to analyse. However, index provider S&P has calculated performance prior to their launch on 23 September through hypothetical back-testing based on the index methodology in place on the launch date.

The results are fairly compelling. Over the past 10 years, the S&P 500 Quality FCF Aristocrats index has returned 13.9% on an annualised total return basis, beating the S&P 500 which has returned 11.1% on the same basis.

The global S&P 500 Developed Quality FCF Aristocrats index has outperformed its base index by an even more impressive degree delivering a 12.7% total return on an annualised basis versus 8.1% for the S&P Developed LargeMidCap.

There are a couple of things to bear in mind. Trackers which seek to simply match the S&P 500 index or another global benchmark are cheaper. For example, the Amundi S&P 500 II ETF (SP5L) is one of the cheapest S&P 500 trackers with ongoing charges of 0.05% per year.

In contrast ongoing charges for the SPDR S&P 500 Quality Aristocrats ETF are 0.25% and the SPDR Developed Quality Aristocrats ETF are 0.35%, respectively.

As previously discussed the quality aristocrats ETFs constituents are predominantly large and midcap US stocks from the technology sector including the Magnificent Seven so there are risks performance is closely tied to a relatively small number of super-sized businesses.

Also, as discussed the past performance currently available is hypothetical as the indices were only launched last September, so investors will need to wait a bit longer to get an ‘actual’ performance history of any meaningful length.

THE BROADER QUALITY ETF UNIVERSE

There are other quality ETFs and indices which have been around for longer but they face the same issue which is the question of how to define what a quality company is. Determining what represents a quality stock is subjective and there is no universal definition. Some might argue you need the expertise of a professional fund manager to spot genuine quality.

However, it does help if a company exhibits strong fundamentals in terms of profitability and pricing power, earnings quality, a proven track record (preferably over 10 years or more) and potentially a strong brand that enhances their competitive position. Some of these can certainly be captured through an index-backed product.

An ETF which could be placed in the quality category and focuses heavily on brands is L&G Global Brands ETF (LABL). This has returned 36.8% over the past year and includes Amazon (AMZN:NASDAQ) and Tesla (TSLA:NASDAQ) in its top 10 holdings.

There are also impressive returns from iShares Edge MSCI USA Quality Factor ETF (IUQA) which has returned 27.2% to investors over the past year. This ETF includes Apple, Nvidia, US pharmaceutical giant Eli Lilly (LLY:NYSE) in its top 10.

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