Growth, growth, and more growth — that’s been the common refrain in the current market environment. However, peeking from behind the curtains is the quality factor. While it has yet to receive the full spotlight in 2025 relative to growth, it’s due for a breakout performance (potentially in 2026).
Christopher Dahlin, Invesco senior factor & core equity strategist and Lance Humphrey, head of portfolio management at VictoryShares and Solutions, joined TMX VettaFi Industry Analyst Cinthia Murphy during a 2026 Market Outlook Symposium to discuss quality opportunities in today’s market.
Quality: What Is It?
As mentioned, large-cap growth has been the primary driver of alpha this year with the artificial intelligence (AI) theme taking center stage. However, the markets are starting to question whether valuations in big tech companies are becoming frothy when compared to their underlying fundamentals. Ensuing volatility in November served a reminder to investors that while growth has been the dominant factor, there’s plenty of room for quality in a portfolio.
But what exactly defines quality?
“Quality is the most subjective or interpretive, in terms of the characteristics that go into a quality company,” said Dahlin. He added that the primary characteristics of quality fall within three categories. “Some level of profitability, earnings quality, and some variation of financial robustness or a prudent capital structure.”
That said, Invesco takes a focused approach to quality by focusing on profitability (return on equity), earnings quality (accruals ratio), and financial soundness by looking at a company’s debt ratio. It mimics the S&P metrics, which serves as the foundation for their quality-focused ETFs.
At Victory Capital, all quality measures can flow into one single metric: free cash flow (FCF). By using a company’s FCF, Victory Capital, by way of their VictoryShares free cash flow ETFs, can identify opportunities that exhibit quality-like characteristics.
“The way we think about quality is through the lens of quality value and quality growth centered around the concept of free cash flow,” Humphrey said.
“We find historically that free cash flow tends to be a more effective measure to gauge the fundamental health of a company, whether it’s on the value side or the growth side,” Humphrey added.
The Quality Comeback
While investors have remained focused on growth, a strong market has also paved the way for more allocation to quality. Dhalin and Humphrey were asked by Murphy to posit on why demand is picking up. One reason is that quality has an open-ended definition, meaning it has the ability to make its presence known in various market conditions.
“Quality has been unconstrained,” said Dhalin. “The one hallmark of quality is that it’s hard to pin it into a stylebox or sector.”
At Victory Capital, Humphrey mentioned that demand for free cash flow ETFs speaks to the demand for more quality even in today’s growth environment.
“Free cash flow has been a better expression of value and profitability,” said Humphrey. He added that a “free cash flow approach to quality/value has had the ability to keep up in these Magnificent Seven, AI-fueled environments.”
Given that the current market environment is still fraught with unknowns related to tariffs, sticky inflation, geopolitical tensions, and a weakening dollar via interest rate cuts, quality can also be a means of defensive portfolio positioning. That said, quality has the ability to capture the upside when markets are trending higher. It can also mitigate downside risk by focusing on companies that can weather the storm during a downturn.
“For investor who wants defensiveness, quality can help,” confirmed Dahlin.
Quality-Focused ETFs
Invesco has a trio of funds that can target quality companies: the Invesco S&P 500 Quality ETF (SPHQ), the S&P MidCap Quality ETF (XMHQ), and the Invesco S&P SmallCap Quality ETF (XSHQ). The product availability for all market capitalizations is proof that quality extraction is available not just in large-caps, but also small- and midcaps.
“They provide quality exposure up and down the cap spectrum for clients building their portfolios using capitalization ranges,” Dahlin said.
As Humphrey mentioned during the symposium, investors have the ability to capture exposure to funds solely dedicated to the FCF metric via a quintet of VictoryShares ETFs. This speaks to the versatility of using the FCF metric. VictoryShares has ETFs for both domestic and international equities as well as for large- or small-caps. On that note, mentioned during the symposium was the VictoryShares Free Cash Flow ETF (VFLO) and the VictoryShares Small Cap Free Cash Flow ETF (SFLO). Using a discernible FCF screener, VFLO and SFLO look at a company’s expected free cash flow as opposed to relying on past data from trailing cash flow figures — a prime benefit when projecting future cash flows as 2025 comes to a close.
“As we look towards 2026 with the concern of valuations in a portfolio, free cash flow has the ability to still keep up if the same market environments persists,” said Humphrey.
To view the symposium in its entirety, click here.
VettaFi LLC (“VettaFi”) is the index provider for VFLO and SFLO, for which it receives an index licensing fee. However, VFLO and SFLO are not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of VFLO or SFLO.
For more news, information, and analysis, visit VettaFi | ETF Trends.
Originally published on ETF Trends
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