Quality in Active Equity Investing
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Alpha Europe Drew's Views
ALPHA EUROPE DREW’S VIEWS ___________________________________________________________________________ Peak Quality? The message below is quite compelling: “We have a quality-focused investment philosophy, and own the best companies for the long term.” Tough to argue with that one, right? Basically, it is the polar opposite of what must be the worst pitch of all time: “We focus on horrible management teams and low quality businesses, and like to own the lousiest company for as short a period as possible, and then turn our portfolio over by selling one miserable business model and buying an even worse one.” Well, fuelled by some excellent academic research over the last five years, as well as the ever-intensifying canonization of Warren Buffett, Mr. Market has been increasingly attracted to and enamoured by the concept of “quality” investing. So, let’s explore it. What is Quality? Wikipedia tells us that: “Quality Investing is an investment strategy based on a set of clearly-defined fundamental criteria that seeks to identify companies with outstanding quality characteristics.” So far, that tells us exactly nothing. They continue, however, with: “The quality assessment is made based on soft (e.g. management credibility” and hard criteria (balance sheet stability).” This is a little less amorphous, but one of our peers has written an excellent book Quality Investing: Owning the best companies for the long term, and have done an even better job than Wikipedia.1 In it, they write that there are three broad characteristics that indicate quality; “strong, predictable cash generation”, “sustainably high returns on capital”, and “attractive growth opportunities”. They do not mention anything about value as a condition, however they do (rightly) suggest that the combination of the three factors above are “particularly powerful, enabling a virtuous circle of cash flow generation, which can be Hurry up guys, there might be a storm headed our way. -
Schroders QEP Why Quality Stocks Offer Higher Return and Lower Risk
Schroders QEP [For professional clients only. Not suitable for retail clients] Schroders QEP Why Quality stocks offer higher return and lower risk For many years, investors thought of “Growth” investing as the natural complement to Value based investment strategies. However, disappointment with the diversification properties of Growth and the failure to identify a sustainable return premium attached to Growth stocks has more recently revived interest in the concept of Quality as both a stand-alone strategy and one that is highly diversifying with Value. The Schroders QEP Global Equity Team has been studying the merits of investing in Quality for almost two decades and has offered a stand-alone Global Quality strategy since 2007. The strategy invests in financially strong companies that have a demonstrated record of generating superior and stable profitability. We believe that Quality is a more systematic and predictable investment approach than typical growth investing as it explicitly avoids the disappointment that is often associated with more glamorous stocks. More specifically, our analysis suggests that Quality companies generate a return premium in excess of the market over time with lower risk whilst we also observe that this return is accentuated when risk aversion is high or rising. Historically, many of these periods have often been associated with Value strategies underperforming, meaning that Quality also appears to offer significant strategic diversification to Value approaches. The complementary role of Value and Quality does not appear to be spurious. We observe that higher quality companies have very different characteristics to Value stocks which are often less profitable, more cyclical and exhibit weaker balance sheets. -
The Power of Quality Investing International Quality Growth the Power of Quality Investing
International Quality Growth The Power of Quality Investing International Quality Growth The Power of Quality Investing Buy quality companies. It seems intuitively like a cash flow return on investment, and return on equity—is straightforward path to investment success, and history the most important metric, and the driver of the other supports the argument. As an investment style, however, two components used by MSCI. Importantly, companies quality does not get nearly the attention of value (buying with high financial productivity have also consistently cheap companies) or growth (buying fast-growing companies). outperformed other companies since at least 1998, based on Yet, quality has outperformed both value and growth since our analysis. MSCI began tracking it in international markets in 2001. It has even outperformed a theoretical investor who started in value The market often undervalues financially productive and timed the switch to growth perfectly in August 2009— businesses because it assumes, based on economic timing the market being a feat in itself (Exhibit 1). theory, that competitors will slowly (or not so slowly) nibble away a company’s edge, and therefore, its outsized Even more curious than the fact that such a successful profitability. In our view, however, certain companies have strategy is often sidelined in investment debates is that such strong barriers to competition that they can maintain the definition of “quality” is often, at least in our view, high financial productivity for longer than the market profoundly misunderstood. MSCI defines quality as a expects. The length of time a company can maintain its combination of financial productivity, low leverage, and competitive advantage, and therefore its extraordinary stability. -
The Case for Empowering Quality Shareholders
GW Law Faculty Publications & Other Works Faculty Scholarship 2020 The Case for Empowering Quality Shareholders Lawrence A. Cunningham Follow this and additional works at: https://scholarship.law.gwu.edu/faculty_publications Part of the Law Commons THE CASE FOR EMPOWERING QUALITY SHAREHOLDERS by LAWRENCE A. CUNNINGHAM THE GEORGE WASHINGTON UNIVERSITY Forthcoming in Brigham Young University Law Review (2020) ABSTRACT Anyone can buy stock in a public company, but not all shareholders are equally committed to a company’s long-term success. In an increasingly fragmented financial world, shareholders’ attitudes toward the companies in which they invest vary widely, from time horizon to conviction. Faced with indexers, short-term traders, and activists, it is more important than ever for businesses to ensure that their shareholders are dedicated to their missions. Today’s companies need “quality shareholders,” as Warren Buffett called those who “load up and stick around,” or buy large stakes and hold for long periods. While scholars in recent years have extensively debated indexers, short-term traders, and activists, they have paid scant attention to quality shareholders and their critical role in corporate finance and governance. This Article corrects this oversight by highlighting the quality shareholder cohort. Adding this fresh perspective confirms some of the angst about myopic short- termism on the one hand and ignorant indexing on the other, but rather than regulate related behaviors, the fresh perspective invites attention to empowering quality shareholders. In particular, rather than taxing short-term shareholders or passing through indexer voting rights, this Article explains how companies could simply increase the voting power of their quality shareholders.