Quality Time: Understanding Factor Investing

When MSCI first published this paper in 2015, quality was a relatively new factor and fewer investors were looking to incorporate it into their allocations compared to more established factors such as value or momentum. However, much has changed since then.

The latest edition examines the effects of these changes, including a new look at the three descriptors used to construct the MSCI Quality Indexes: return-on-equity (ROE); debt-to-equity (D/E) and earnings variability (EVAR). Understanding how descriptor performance manifests itself could help us understand if the factor premia were driven by good performance of high quality or by poor performance of low-quality stocks.

As shown below, the performance of each descriptor has been quite consistent over the period. Interestingly, the combination of the three descriptors has posted better performance than the individual descriptors over the long run.

Performance of top minus bottom decile portfolios

Period: November 2002 – March 2023. Gross returns annualized in USD. Deciles are equally sized and equally weighted semiannually. Returns are gross in USD and relative to the MSCI World Equal Weighted index. “Top” leverage (D/E) and earnings var deciles are represented by companies with low leverage and low earnings variability respectively.