The Defense-Meets-Offense Appeal of Quality Growth ETFs

Since the market low on April 8th, growth stocks, particularly those emphasizing 'quality growth' defined by profitability and free cash flow, have outperformed value, driven by strong Q1 earnings from the 'Magnificent 7'. ETFs like VictoryShares Free Cash Flow Growth ETF (GFLW), Dimensional US High Profitability ETF (DUHP), and American Century US Quality Growth ETF (QGRO) are gaining traction, attracting significant asset flows as investors seek a defensive approach to growth amid economic uncertainty, focusing on metrics like return on equity and gross margin over traditional growth metrics such as EPS growth.

Analysis

The market has demonstrated a significant rotation towards growth stocks since the April 8 low, reversing the earlier year-to-date trend where value, represented by Vanguard’s VTV, had outperformed growth (VUG) by at least 10 percentage points. This shift was notably propelled by a largely positive Q1 earnings season for the "Magnificent 7" companies, which reported a collective earnings growth rate of 27.7%, exceeding market expectations. Despite persistent macroeconomic uncertainties related to tariff policy, mixed economic data, and geopolitical tensions, investor interest is increasingly focused on "quality growth." This approach, underscored by Professor Robert Novy-Marx's research on the gross profitability premium, prioritizes companies with strong profitability and free cash flow generation. Exchange-Traded Funds (ETFs) specializing in this factor, such as VictoryShares Free Cash Flow Growth ETF (GFLW), Dimensional US High Profitability ETF (DUHP), and American Century US Quality Growth ETF (QGRO), have exhibited robust performance and substantial asset inflows. Since April 8, GFLW has risen 28%, DUHP by over 16%, and QGRO by approximately 25%, with GFLW and VUG outperforming the S&P 500 (SPY). GFLW has attracted $420 million in net assets in 2025, DUHP has seen over $850 million in YTD inflows, and QGRO has garnered $435 million, reflecting a strategic move by investors towards growth strategies with a defensive characteristic, favoring metrics like return on equity and gross margin over traditional high-growth indicators.

Key Decisions for Investors

• Investors should consider increasing exposure to 'quality growth' strategies, focusing on companies demonstrating high profitability and strong free cash flow generation, given their recent market outperformance and potential resilience.
• Evaluate ETFs specifically designed to capture quality growth, such as GFLW, DUHP, and QGRO, which have shown positive performance trends and attracted significant investor capital, as potential vehicles for this thematic allocation.
• When selecting individual growth stocks, prioritize those with robust profitability metrics, including return on equity and gross margins, as these are highlighted as more significant drivers of long-term returns than high sales or earnings growth rates in isolation.
• Maintain awareness of ongoing economic uncertainties and geopolitical risks, utilizing quality growth as a strategic approach to participate in growth opportunities while incorporating a defensive element into portfolios.