We’d all like to invest in high quality companies without the pain of trying to pick them. Can the Betashares Australian Quality ETF (ASX: AQLT) be the solution?
What does “quality” mean?
First of all, what does a “quality” company actually look like?
Trying to base an assessment of a company’s quality on historical share price performance won’t tell us much. To identify whether a company would make a high quality investment or not, we need to look under the hood.
There are many ways you could go about this. If you look at the ASX page for a company like Commonwealth Bank of Australia (ASX: CBA) or CSL Ltd (ASX: CSL) you’ll find every metric under the sun, from cash flow and net profit, to earnings per share and price-equity ratios.
All of these figures can give you some idea as to the quality of the company but it’s fairly limited, especially because it’s only giving you information for a moment in time. To get a true indication of quality, we need to consider how a company performs over time.
However, once you start looking into balance sheets and financial metrics over multiple years and multiple companies, things start to get complicated fast. So, can you just use an exchange traded fund (ETF) to pick out these quality shares instead?
The AQLT ETF approach
The Betashares Australian Quality ETF (ASX: AQLT) tries to solve exactly this problem. It offers investors the chance to invest in high quality Australian companies without the hassle of trying to pick them out yourself.
So, what do they consider to be the important metrics?
The AQLT ETF looks at three metrics:
- Return on equity
- Leverage
- Earnings stability
Let’s breakdown some of the jargon here.
First, return on equity. Return on equity, or ROE, is a measure of financial performance that looks at a company’s net income compared to total shareholder equity (basically a company’s net worth, assets minus debts). A high ROE means that the company is generating a high return on its net assets.
Much like an investor wants to generate a high return on their invested capital, a company wants a high return on its net assets.
Second is leverage. Leverage refers to how much debt a company has relative to its assets. AQLT looks for companies with low leverage, or low levels of debt. This could mean that the company is in a stronger financial position and less vulnerable to interest rate changes than a company with high amounts of debt.
Finally, earnings stability. This one is pretty straightforward – it’s the companies ability to generate consistent profits over time. A company with high earnings stability has likely been making a good profit for a number of years. It may not be rapidly growing, but it’s dependable.
What’s inside the AQLT ETF?
So, when we put these rules in place – high ROE, low leverage, high earnings stability – what are we left with?
The AQLT ETF looks a bit different to, say, the Vanguard Australian Shares Index ETF (ASX: VAS). VAS invests in the 300 largest Australian companies which over-indexes in financial companies (mostly banks) and materials companies like BHP Group Ltd (ASX: BHP).
The biggest difference between AQLT and VAS is the exposure to minerals and mining. AQLT has a much lower exposure to mining companies, likely because of the earnings stability metric. Mining companies are heavily exposed to commodity prices so can be more volatile than something like a consumer staples company.
Other than that, the top 10 holdings will be familiar to most Australian investors. AQLT still has a high exposure to companies like CBA, CSL, and Macquarie Group Ltd (ASX: MQG).
Most importantly, does this “quality” approach work?
The AQLT ETF aims to outperform the ASX 200 and, in its short time in existence, it has comfortably done that. AQLT returned over 21% over the last 12 months compared to ~13% from the ASX 200. While past performance is not a reliable indicator of future performance it does give some indication that this quality approach has been working in a period of rising interest rates.
The AQLT ETF charges a reasonable management fee of 0.35% per year and pays out dividends twice per year as well. This is an ETF I’ll be keeping a close eye on over the next 12 months.
