Pros and cons of quality factor at this time.

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Lauretta
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Pros and cons of quality factor at this time.

Post by Lauretta » Mon Jun 29, 2020 9:57 am

I have quite a big sum to invest in the coming weeks and I read some articles in favour of quality factor investing at this time of coronavirus crisis. I also listened to an interview by Ray Dalio; he said that stocks are a good investment (as opposed to bonds) but that there will be a huge difference between companies, with those with strong balance sheets faring much better. So if you can't do stock picking, probably the best way to act on Dalio's recommendation is to have a quality factor ETF(?) I imagine in case things go haywire with the virus, these stocks should suffer less(?)

On the other hand the disadvantages to me seem to be (apart the higer fees) that people must have figured this out so these stocks should be more expensive by now.

Any thoughts would be welcome
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Scooter57
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Re: Pros and cons of quality factor at this time.

Post by Scooter57 » Mon Jun 29, 2020 10:49 am

The problem seems to me to lie in how you define "Quality." There are as many ways to define it as there are companies putting together seductive packages for investors, many of whom are too naive to look under the hood or are prevented from doing it by the limited amount of information the ETF provider makes public.

If you are using some kind of screen that just plugs numbers from a balance sheet into a formula you are going to miss a lot of what makes a company a good or bad investment. Buffett in his heyday made a big deal about how he assessed the quality of the executives running a business, which is something you can't see on a spreadsheet.

You also have the issue that a company that looks good on paper may be facing conditions in the marketplace that haven't hit its financials YET. The coronavirus has made that a huge problem for anyone trying to assess quality because we don't have the numbers that will show the impact of the widespread shutdowns on most businesses. More than that, though, you have longer term issues that the human brain can think through but a spreadsheet that analyzes financials cannot. If you use analyst projections as part of your quality screen you still have the problem that they are wrong more than they are right (which you can verify with software like F.A.S.T.Graphs which plots analyst projections against actuals for a decade.)

This is the same problem with so called "value" funds and ETFs, which, because they use a limited number of formulas applied to financial statements mix in failing companies whose price reflects what they are really worth with the elusive hidden gem that is priced below what it will be worth shortly.

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Steve Reading
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Re: Pros and cons of quality factor at this time.

Post by Steve Reading » Mon Jun 29, 2020 11:10 am

Lauretta wrote:
Mon Jun 29, 2020 9:57 am
I have quite a big sum to invest in the coming weeks and I read some articles in favour of quality factor investing at this time of coronavirus crisis. I also listened to an interview by Ray Dalio; he said that stocks are a good investment (as opposed to bonds) but that there will be a huge difference between companies, with those with strong balance sheets faring much better. So if you can't do stock picking, probably the best way to act on Dalio's recommendation is to have a quality factor ETF(?) I imagine in case things go haywire with the virus, these stocks should suffer less(?)

On the other hand the disadvantages to me seem to be (apart the higer fees) that people must have figured this out so these stocks should be more expensive by now.

Any thoughts would be welcome
In your particular situation, I think you could consider ignoring Siegel telling you to overweigh stocks, Dalio telling you to overweigh quality, etc and just buy yourself a globally diversified stock index fund (how about SWRD?), and pair with a globally-diversified nominal bond fund (how about AGGH?) and inflation-linked Euro bonds.

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Re: Pros and cons of quality factor at this time.

Post by Lauretta » Mon Jun 29, 2020 11:13 am

Scooter57 wrote:
Mon Jun 29, 2020 10:49 am
The problem seems to me to lie in how you define "Quality." There are as many ways to define it as there are companies putting together seductive packages for investors, many of whom are too naive to look under the hood or are prevented from doing it by the limited amount of information the ETF provider makes public.

If you are using some kind of screen that just plugs numbers from a balance sheet into a formula you are going to miss a lot of what makes a company a good or bad investment. Buffett in his heyday made a big deal about how he assessed the quality of the executives running a business, which is something you can't see on a spreadsheet.

You also have the issue that a company that looks good on paper may be facing conditions in the marketplace that haven't hit its financials YET. The coronavirus has made that a huge problem for anyone trying to assess quality because we don't have the numbers that will show the impact of the widespread shutdowns on most businesses. More than that, though, you have longer term issues that the human brain can think through but a spreadsheet that analyzes financials cannot. If you use analyst projections as part of your quality screen you still have the problem that they are wrong more than they are right (which you can verify with software like F.A.S.T.Graphs which plots analyst projections against actuals for a decade.)

This is the same problem with so called "value" funds and ETFs, which, because they use a limited number of formulas applied to financial statements mix in failing companies whose price reflects what they are really worth with the elusive hidden gem that is priced below what it will be worth shortly.
Thanks, yes I understad your point. So when someone who can pick stocks like Dalio talks of quality stocks, these are not the same as those in a quality ETF, in the same way as value investing using Ben Graham method is not the same as quantitative value done by a value fund or ETF. Still, AQR for example or DFA do quantitative value which seems to have worked over time (though not lately :wink: ) Probably the same is the case for quality ETF? I mean, they might still have some benefit even though they are not the same as having an expert analyse the company(?)
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Re: Pros and cons of quality factor at this time.

Post by Lauretta » Mon Jun 29, 2020 11:18 am

Steve Reading wrote:
Mon Jun 29, 2020 11:10 am
Lauretta wrote:
Mon Jun 29, 2020 9:57 am
I have quite a big sum to invest in the coming weeks and I read some articles in favour of quality factor investing at this time of coronavirus crisis. I also listened to an interview by Ray Dalio; he said that stocks are a good investment (as opposed to bonds) but that there will be a huge difference between companies, with those with strong balance sheets faring much better. So if you can't do stock picking, probably the best way to act on Dalio's recommendation is to have a quality factor ETF(?) I imagine in case things go haywire with the virus, these stocks should suffer less(?)

On the other hand the disadvantages to me seem to be (apart the higer fees) that people must have figured this out so these stocks should be more expensive by now.

Any thoughts would be welcome
In your particular situation, I think you could consider ignoring Siegel telling you to overweigh stocks, Dalio telling you to overweigh quality, etc and just buy yourself a globally diversified stock index fund (how about SWRD?), and pair with a globally-diversified nominal bond fund (how about AGGH?) and inflation-linked Euro bonds.
SWRD is quite cool; I have cut and sliced so far because of lower fees (e.g. CSP1 for US etc) but 0.12% is pretty low thanks, and indeed I see more and more the advantage of simplicity.
Inflation linked euro bonds bother me because of negative yeilds; still they would be a hedge for unexpected inflation. But perhaps I'll go for gold instead of them.
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Re: Pros and cons of quality factor at this time.

Post by alex_686 » Mon Jun 29, 2020 11:28 am

Scooter57 wrote:
Mon Jun 29, 2020 10:49 am
The problem seems to me to lie in how you define "Quality." ... This is the same problem with so called "value" funds and ETFs, which, because they use a limited number of formulas applied to financial statements mix in failing companies whose price reflects what they are really worth with the elusive hidden gem that is priced below what it will be worth shortly.
I will modestly take the other side. "Value" and "Quality" may be mushy subjective ideas that are prone to marketing abuse. "Value Factor" and "Quality Factor" are well defined. Let us not muddy the waters unnecessarily.

I would suggest you try to identity the return factors and risks you want to take. And recognize how these can fail. One downside is that factors tend to cluster within certain sectors, and if those sectors get hit hard - well - issues.

Also take a look at the Minimum Volatility factor.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.

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Re: Pros and cons of quality factor at this time.

Post by Scooter57 » Mon Jun 29, 2020 12:11 pm

alex_686 wrote:
Mon Jun 29, 2020 11:28 am


I will modestly take the other side. "Value" and "Quality" may be mushy subjective ideas that are prone to marketing abuse. "Value Factor" and "Quality Factor" are well defined. Let us not muddy the waters unnecessarily.

I would suggest you try to identity the return factors and risks you want to take. And recognize how these can fail. One downside is that factors tend to cluster within certain sectors, and if those sectors get hit hard - well - issues.
Also take a look at the Minimum Volatility factor.
How is the "quality factor" officially defined and who defines it? Is there any actual standard that fund companies have to adhere to if they slap that label on a fund?

The descriptions funds provide us of the way a fund is invested is pitifully scant and gives the average, not very knowledgeable about investing buyer very little idea of what they are buying and how it has been selected.

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Re: Pros and cons of quality factor at this time.

Post by alex_686 » Mon Jun 29, 2020 12:24 pm

Scooter57 wrote:
Mon Jun 29, 2020 12:11 pm
How is the "quality factor" officially defined and who defines it? Is there any actual standard that fund companies have to adhere to if they slap that label on a fund?
It works just like the Value Factor. You define your universe. Define what percentage is going to fall into that factor. 1/2, 1/3, some blend. Rig a algorithm to rank those securities. Bang.

Quality looks at stability - earnings, return on equity and asset growth. Plus low debt. Tweak for financial companies. Different index providers tweak the algorithm a bit. How much weight to put on one input or another.

But it is top down macro approach. Not a bottom up subjective approach.

https://www.investopedia.com/terms/f/fa ... esting.asp
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.

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Re: Pros and cons of quality factor at this time.

Post by Steve Reading » Mon Jun 29, 2020 12:24 pm

Scooter57 wrote:
Mon Jun 29, 2020 12:11 pm
alex_686 wrote:
Mon Jun 29, 2020 11:28 am


I will modestly take the other side. "Value" and "Quality" may be mushy subjective ideas that are prone to marketing abuse. "Value Factor" and "Quality Factor" are well defined. Let us not muddy the waters unnecessarily.

I would suggest you try to identity the return factors and risks you want to take. And recognize how these can fail. One downside is that factors tend to cluster within certain sectors, and if those sectors get hit hard - well - issues.
Also take a look at the Minimum Volatility factor.
How is the "quality factor" officially defined and who defines it? Is there any actual standard that fund companies have to adhere to if they slap that label on a fund?

The descriptions funds provide us of the way a fund is invested is pitifully scant and gives the average, not very knowledgeable about investing buyer very little idea of what they are buying and how it has been selected.
It might not be officially defined but most quality indices are open about their methodology so you can check it out and see if you like it. There's no subjective, active management. You know what you get in terms of quality so to speak.

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Re: Pros and cons of quality factor at this time.

Post by garlandwhizzer » Mon Jun 29, 2020 1:58 pm

My 2 cents worth. In this recession and the sluggish growth of the last 10 years value has gotten killed while LCG has outperformed. Quality is expected to hold up better in recessions and difficult macroeconomic situations with sluggish growth which is what we've had for more than a decade. In fact QUAL has outperformed VTI (beta) since its inception in 2013. Interestingly both QUAL and VTI have their biggest sector allocations to tech, especially mega-cap tech, and health care. Both are strong sectors loaded with cash on balance sheet and have business models that are more immune to cyclical forces which is precisely why both held up well in the COVID-19 recession relative to say value . If you believe the next ten years are going to be like the last 10, QUAL is the way to go. The problem is that QUAL's strength is not a secret and it is currently richly priced relative to say the decade long loser, Value. Value's long period of struggles have left it now at fire sale prices. If the economy heats up and robust economic growth resumes, SCV's ultra-cheap small struggling companies will likely substantially outperform QUAL. When all boats get lifted by the rising tide of robust economic growth investors are not willing to pay such a high premium for QUAL. Reliable profits are everywhere and a lot cheaper with value stocks than quality stocks.

If you want to pick the single factor winner in advance it helps to know how the current recession is going to play out going forward. Unfortunately no one knows that up front reliably. Holding VTI makes no bets on winners versus losers, only on the overall market, which is IMO usually better than making a bet. QUAL is a good all weather choice with reasonable performance in good economic times in spite of its higher valuations and a bit better insulated in bad times. Value is trickier, lots of upside potential from its current ultra-cheap valuations, but its struggling companies are more vulnerable when the economy takes a downturn.

Where to invest equity assets is a complex question. It is interesting that so may experts trying to pick future winners come up widely differing conclusions on this question. That should tell you something.

Garland Whizzer

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Re: Pros and cons of quality factor at this time.

Post by Lauretta » Mon Jun 29, 2020 2:18 pm

garlandwhizzer wrote:
Mon Jun 29, 2020 1:58 pm
value is trickier, lots of upside potential from its current ultra-cheap valuations, but its struggling companies are more vulnerable when the economy takes a downturn.
yep I know, I have quite a bit in value and it's done terribly. Bought some more last March which has gone up a lot since, but overall it's the worst ETF I have (it's VVAL on the London stock exchange)... That's one of the reason why I thought of a quality ETF as it should perform better if the economy takes a downturn and value get even more punished.
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Scooter57
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Re: Pros and cons of quality factor at this time.

Post by Scooter57 » Tue Jun 30, 2020 9:21 am

The very high valuations on quality stocks would make me think twice. If you combine metrics for both quality and valuation, you end up with far fewer stocks to choose from than the 800 in the Vanguard quality factor ETF.

My own screening along those lines turned up only a few stocks that met both qualifications. Too few for an ETF. I suppose you could broaden the number by adding in many small companies, but they are too subject to dilution, takeovers by larger, poorer quality companies, going private, and other issues. Small cap now is not the small cap of decades ago that all the back testers draw conclusions from.

The original question was about investing a lot of money. If ever there was a time when small investments stretched out over time made more sense than lump summing, this is it.

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Re: Pros and cons of quality factor at this time.

Post by IndexCore » Tue Jun 30, 2020 9:36 am

According to academics, Warren Buffet discovered the "quality" factor decades before anyone else figured it out. The factor he used, and that academics label the "quality factor" is probably what OP intends. Here's the definition on Investopedia:

https://www.investopedia.com/terms/f/fa ... esting.asp
"Quality
Quality is defined by low debt, stable earnings, consistent asset growth, and strong corporate governance. Investors can identify quality stocks by using common financial metrics like a return to equity, debt to equity and earnings variability."


Vanguard has a "quality factor" ETF costing 0.13% expense ratio:
https://investor.vanguard.com/etf/profi ... folio/vfqy

Beating Vanguard on cost is JP Morgan (I'm as surprised to type that as you are to read it!) with a 0.12% expense ratio:
https://etfdb.com/etf/JQUA/#etf-ticker-profile
(JP Morgan has #1 Apple and #3 Visa, which looks more like what Buffet might pick)

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Re: Pros and cons of quality factor at this time.

Post by Forester » Tue Jun 30, 2020 10:16 am

I'd rather own a Min Vol fund than a Quality fund, more direct way of achieving what Quality is striving for.

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