Why investing in quality is crucial in the current market

Why investing in quality is crucial in the current market

Why investing in quality is crucial in the current market

Investing doesn’t need to be complicated – in fact, it should be pretty simple. There’s a long history of investors getting caught out after trying to be too smart; trying to find opportunities that don’t really exist.

The reality is that investing in quality names - market leading companies with a track record of outperformance - is a smart move in any market environment. In time as such as these, with volatility and geopolitical uncertainty playing an increasingly central role, investing in quality isn’t just a smart move – it’s a crucial one.

“Quality-based investing is identifying market-leading companies with sustainable competitive advantages, which tend to outperform over time,” says Chris Heakes, Director, Portfolio Manager, Exchange Traded Funds, BMO GAM. “Having quality companies in your portfolio tends to give you an edge relative to someone without any quality screens in their portfolio. Our Quality ETFs begin with the broad market-cap portfolio, but they are tilted towards quality, with the aim to improve performance over time.”

When selecting companies for its portfolio of Quality ETFs, BMO uses MSCI’s quality index methodology, which ensures that quality screenings are implemented systematically and in a disciplined way. MSCI uses three metrics: high return on equity, stable earnings and low-debt equity. Each metric on its own is not necessarily an indicator of a quality company, but the three combined provide an accurate assessment.

The portfolio construction methodology aims not only to capture the performance of high-quality companies but also to ensure reasonably high-trading liquidity and moderate security turnover while staying cost-effective. Security selection relies on the determination of the three quality metrics, while weighting is based on a combination of the security’s quality scores and market capitalization. Quality indices are rebalanced semi-annually.

As a result, the BMO MSCI All Country World High Quality Index ETF (ZGQ), for instance, has performed better than the broad index over the past six months, as have all Quality ETFs, according to Heakes. From a geographical perspective, BMO GAM’s Quality ETFs portfolio favours the US.

“The US economy is dense, it’s been the global engine of the past three, four years and probably doing the best of any economies in the world,” Heakes says. “Also, a lot of these market-leading companies in the US have operations that go global. On a sector basis, the portfolio tended to overweight IT and underweight financials. IT companies have exhibited some of the best profitability and lowest debt-equity ratios amongst all global stocks; whereas financials with their higher debt load have tended to not make it through the portfolio’s screens.”

Given the current economic and political backdrops, Heakes believes that quality-based investing is more important than ever.

“We’re certainly getting towards the end of the cycle, however solid growth and low unemployment remains in place. In terms of positioning equities, the cautious tilt is wanted, but I think you still want to be invested in equities to take advantage of the last stage of the equity rally,” Heakes says. “Quality investing gives exposure to equity growth, but also defensive positioning should economic conditions change. Quality investing helps get investors into more stable, profitable investments that should help protect value in an equity sell-off.”

 

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