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The importance of quality

Arian Neiron  |  11 Feb 2016Text size  Decrease  Increase  |  

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Arian Neiron is the managing director of Van Eck Global/Market Vectors ETFs Australia. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.

 

"It's quality, rather than quantity, that matters."

The quote may sound like a tag line from a 1950's advertisement, but surprisingly it comes from Roman Emperor Nero's tutor and adviser, Lucius Seneca.

He wasn't talking about stock selection or portfolio construction, but his advice is particularly significant for investors being buffeted by the stormy conditions of 2016 investment markets.

In difficult economic times, a market slump or prolonged recession, quality stocks are more likely to fare better and to recover sooner than speculative shares. Quality companies are more likely to continue growing and paying dividends through the tough times.

That's why, particularly in tough times, there is a "flight to quality".

An emphasis on quality companies is not new--the founding father of value investing, Benjamin Graham, demonstrated the concept in the late 1930s. There was a re-emphasis on quality investing after the dotcom bust at the turn of the century and the collapses of high-growth companies such as Enron and WorldCom.

An investor analysing these companies' balance sheet strength, consistency of earnings and borrowings ratios would have avoided them.

When MSCI set out to develop an index that identified the world's highest quality stocks among the 1,581 companies in its benchmark MSCI World ex-Australia Index, it established criteria, based on Graham's own quality factors, to select the 300 with best combined "quality score" based on:

• high return on equity;
• stable year-on-year earnings growth; and
• low financial leverage.

The Market Vectors MSCI World ex Australia Quality ETF (QUAL) tracks the MSCI World ex Australia Quality Index. This means that Australian investors can now access a portfolio of 300 quality international companies in a single trade on the ASX.

Despite the volatility and global economic concerns, quality international companies had a strong 2015 as QUAL outperformed the MSCI World ex Australia Index by 4.27 per cent, returning 16.07 per cent (source: Market Vectors, Morningstar Direct).