Even as Claude developer Anthropic prepares to launch its massive initial public offering, technology stocks have been incredibly volatile -- reflecting the seemingly endless market debate over what's next for the artificial-intelligence trade.
For investors, that might indicate that it is time to look at funds that own quality stocks: companies with solid earnings, low debt levels, and reasonable valuations.
That doesn't mean you have to exclude AI entirely. But you should cast a wider net. That said, you need to pay close attention to the funds that claim to cover a wide swath of equities.
For example: The iShares Edge MSCI USA Quality Factor exchange-traded fund, with nearly $50 billion in assets under management, is the largest of these types of funds. But the passively managed fund is heavily exposed to AI, with Microsoft, Apple, and Nvidia as its top three holdings and 35% of the portfolio in tech stocks.
Tom Essaye, editor of the Sevens Report newsletter, points out that the actively managed Vanguard U.S. Quality Factor ETF has only 20% allocated to tech, and that no single stock accounts for more than 2% of the fund. Top holdings include biotech Gilead Sciences, 3M, and uniform company Cintas.
Essaye says companies both in tech and outside of the sector "that don't need...capital, i.e., large-cap companies with strong balance sheets" should be market winners. To that end, both quality funds are beating the S&P 500's 11% return so far this year, with Vanguard's up 16% and the iShares ETF gaining 13%.
So, your choice of which quality fund to buy depends on how much AI risk you want to take. They have similar fee structures, as well; the iShares fund has an expense ratio of 0.15%, slightly higher than Vanguard's 0.13%.
There are two other funds that look intriguing -- one passive and another that's active, but both based on systematic rules that focus on stocks with strong cash flows. The VictoryShares Free Cash Flow ETF, up nearly 35% this year, is the passive fund. The index it's based on, managed by VettaFi, looks for stocks with a high free cash flow yield -- annual cash flow divided by market value. Lance Humphrey, head of portfolio management for VictoryShares and Solutions, says this helps the fund avoid so-called value traps -- stocks that are cheap for a good reason.
Tech is a part of the story. Micron Technology is the seventh-largest holding. But the top four weightings represent a broader mix, with Accenture, Marathon Petroleum, health insurer Centene, and ExxonMobil accounting for 15% of the assets. The fund has an expense ratio of about 0.4%. And despite the strong run this year, the ETF trades for less than 11 times earnings estimates for the next 12 months.
"This year has finally been a value-driven market," Humphrey says. "It is exactly the type of environment we'd expect to do well in."
The Astoria US Equal Weight Quality Kings ETF also takes a diverse approach to finding quality stocks. The fund, run by Astoria Investment Management founder and CEO John Davi, buys equal-weighted positions in companies across the entire spectrum of the economy. "The broadening out trade has occurred," Davi says. "We want a lot more diversification. The economy is strong."
He adds, "Why do you need to put all your eggs into just seven stocks?"
The Astoria ETF doesn't avoid tech. Software stocks PTC and Gen Digital are among the 10 largest positions in the fund. But so are toy maker Hasbro, drug distributors McKesson and Cardinal Health, defense contractor Lockheed Martin, and advertising agency Omnicom. The fund is on the pricier side, with an expense ratio of just under 0.5%. But the strategy is working. The ETF is beating the market handily, with a year-to-date return of 20%.
These quality stock funds, if you choose that route, should continue to show momentum now that investors are banking on stronger earnings growth from the other 493 of the S&P 500.
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