Quality factor

The quality factor identifies companies that earn consistently high returns on equity, produce earnings that don't wobble with the economic cycle, and carry relatively little debt. Portfolios tilted toward these names have historically produced returns similar to or modestly above the broad market, but with lower volatility and shallower drawdowns — meaning stronger risk-adjusted returns.

Quality is defined differently by different index providers. Common ingredients: return on equity or return on invested capital, earnings stability, low financial leverage (debt-to-equity), and sometimes gross profitability (gross profits divided by total assets). Because the definitions vary, two "quality" ETFs can have materially different holdings.

Quality tends to hold up relatively well during market stress — high-profitability, low-leverage companies are the ones least likely to cut the dividend, get distressed, or be squeezed out of the market during a recession. The trade-off is that quality can lag in sharp risk-on rallies led by lower-quality, more speculative names.