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Quality Investing

An approach for investing through the cycle, resilient to economic headwinds and market drawdowns.

Buying Quality companies seems an intuitively straightforward path to investment success. History supports the argument. The difficulty for investors is identifying those companies that are truly "Quality".

Concept of Quality

The Quality factor is described in academic literature as companies with durable business models and sustainable competitive advantages.

Warren Buffet’s mentor Benjamin Graham, Jeremy Grantham from Grantham, Mayo, & van Otterloo (GMO) and the economist Robert Novy-Marx are well known proponents of Quality investing. They all exhibited a rigorous focus on Quality attributes of stocks.

In what is considered one of the world’s best investing almanacs “The Intelligent Investor”, Benjamin Graham outlines some of the fundamental measures he looks for in a company. There are seven in total but ones that investors should not ignore include a sufficiently strong financial condition, earnings stability and earnings growth.

A recurring theme of The Intelligent Investor is that investors should demand from a company "a sufficiently strong financial position and the potential that its earnings will at least be maintained over the years.”

Adequate size of the enterprise
Earnings growth
Sufficiently strong financial condition
Moderate ratio of Price to Assets
Earning stability
Moderate Price to Earnings ratio
Dividend record

Authors Quality aspect Summary
Benjamin Graham
(1937)

Profitability

Stability

Earnings Quality

  • Adequate size of enterprise, sufficiently strong financial position, earnings stability, dividend record, earnings growth, moderate P/E and PB ratios
Richard Sloan
(1996)

Earnings Quality

  • Accrual anomaly was reported
  • Accounting accruals (the non-cash component of earnings) are negatively correlated with future stock returns
GMO white paper
(2004)

Profitability

Stable Earnings Low Debt

  • High-Quality firms are likely to be underpriced due to low volatility
Robert Novy-Marx
(2012)

Profitability

  • Profitable firms generate significantly higher returns than unprofitable firms, despite having significantly higher valuation ratios
Max Kozlov and Antii Petajisto
(2013)

Earnings Quality

  • Long stocks with high earnings Quality and short stocks with low earnings Quality (accruals) earned positive risk premium
  • Global earnings Quality portfolio produced a higher Sharpe ratio against market and value or small-cap strategies
  • Quality complements value investing thanks to its negative correlation to value
Clifford S. Asness, Andrea Frazzini, and Lasse H Perdersen
(2013)

Growth

Payout

Profitability

Safety

  • Quality stocks are defined to be safe, profitable, growing and well managed
  • Quality strategy produced information ratio above 1 in the US and globally (24 countries)
Eugene F. Fama, Kenneth R. French
(2014)

Quality and Profitability

  • Size, value, profitability and investment patterns
  • By adding two new factors, average stock returns performed better than the three-factor model
  • Downside: Adding the new factors made value factor became less explanatory

MSCI Quality Indices

MSCI, one of the world’s largest index providers, analyses all of the companies in its universe and creates its Quality Indices based on the basis of three key Quality factors:

Identifiable metric:

1. High return on equity

Shows how effectively a company uses investments to generate earnings growth

Identifiable metric:

2. Low leverage/low debt

A measure of company leverage; and

Identifiable metric:

3. Earnings stability

How smooth recent earnings growth has been

Resources

pdf

International equities:
Quality through the cycle

 

view the pdf

pdf

Other approaches to Quality

We found that in Australian small companies, by focusing on dividend payers, the resulting portfolio has a Quality tilt.

view the pdf

Explore our Quality ETFs

We offer three international equity ETFs that utilise MSCI’s Quality approach

International equities

QUAL

VanEck MSCI International Quality ETF

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International equities (hedged)

QHAL

VanEck MSCI International Quality (Hedged) ETF

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International small companies

QSML

VanEck MSCI International Small Companies Quality ETF

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We also offer an Australian Small Companies ETF that focuses on dividend payers which has been shown to result in a Quality tilt.

Australian Small Companies

MVS

VanEck Small Companies Masters ETF

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Key risks: Investments in ETFs carry risks associated with financial markets generally, individual company management, industry sectors, fund operations and tracking an index. See the PDS and TMD for more details on risks and whether these products are appropriate for you. Investment returns and capital are not guaranteed.