June began with a rocky start for markets as worries about economic health rose. However, quality companies offer opportunities for investors seeking to hedge against economic uncertainty.
The May reading for the ISM Manufacturing Index measured 48.7. Readings below 50 indicate contraction. The reading joins a growing array of economic indicators pointing to economic slowing. Consumer spending pullbacks alongside job market slowing could challenge economic resilience.
While beneficial for interest rate-cut outlooks, too much slowing could lead to a recession. The Atlanta Fed’s forecasts for the second quarter of U.S. GDP dropped significantly on the ISM Manufacturing news. GDPNow currently forecasts 1.8% growth in Q2, down from earlier estimates of 2.7%.
See also: “Quality is an All-Weather Investment Strategy”
The quality factor could prove beneficial in times of uncertainty and volatility. Quality focuses on companies with a resilient business model that can generate stable earnings with low leverage across business cycles.
Considering a business’s health during economic strain allows for defensive portfolio positioning. Looking beyond valuations and considering how heavily levered a company is via its debts helps identify resilient companies. In periods of high rates, highly levered companies face the potential for greater challenges than those companies with fewer debts and strong balance sheets.
Income Investing With High-Quality Companies
Quality investing potential isn’t just constrained to times of uncertainty, however. In fact, over longer timelines, the quality factor offers outperformance above other targeted factor strategies.
Image source: Gateway Investment Advisers
Gateway Investment Advisers, the manager of GQI, takes quality investing one step further in the metrics it utilizes to measure quality. The Quality Score employed in the Natixis Gateway Quality Income ETF (GQI) seeks to identify “opportunities to maximize profitability metrics and minimize leverage metrics,” according to a paper published earlier this year.
In seeking to maximize profitability, the strategy measures six data points of a company. These include return-on-equity, return-on-assets, cash-flow-to-assets, cash-flow-to-income, gross margin, and sales-to-assets. When minimizing a levered company, the strategy includes a company’s debt-to-assets and debt-to-equity. All of the data is combined into a single quality score, and those companies with the highest scores from the S&P 500® Index are included in the fund.
The equity exposures are then complemented by a laddered call option strategy on the S&P 500 Index. The options overlay half the portfolio. This allows the other half to participate in market upswings, balancing capital appreciation with income potential.
The fund provides risk-adjusted exposure to equities, making it a strong complement to existing equity allocations. Volatility mitigation also complements other minimum volatility strategies.
GQI works well within an income sleeve as an alternative to dividend-yield strategies. Because of its lack of interest rate risk, it also makes for a good addition to existing credit allocations. It is a strong diversifier to high-yield or other existing credit strategies within a portfolio.
GQI is actively managed by Gateway Investment Advisers. It’s fully transparent, with an expense ratio of 0.34%.
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