Quality: A Distinct Equity Factor?

22 Pages Posted: 27 Jul 2014

See all articles by Daniel Ung

Daniel Ung

CFA Institute; Chartered Alternative Investment Analyst Association (CAIA); Global Association of Risk Professionals

Priscilla Luk

S&P Dow Jones Indices

Xiaowei Kang

Standard & Poor's

Date Written: July 26, 2014

Abstract

Size, momentum, volatility and value have all been shown to be partly responsible for explaining equity returns over the long run but they do not seem to fully capture the returns of some companies. This has therefore given credence to the idea that a fifth factor – quality – exists and, when combined with other risk factors, acts as a good diversifier in investment portfolios.

There isn’t much agreement on what ‘quality’ is or how it should be measured. Some simply equate it to profitability and others, believing it to be a multi-faceted concept, use more complex measures (e.g. the Piotroski’s F score). Regardless of the approach taken, the aim of any quality measure should help estimate a company’s future profitability and understand its source of risk. Broadly speaking, high-quality companies should generate higher revenue and enjoy more stable growth than the average company. This is why we believe that any good quality measure should take into account profitability generation, earnings quality and financial robustness.

Keywords: smart beta; alternative beta; advanced beta; tilts; value; size; momentum; low volatility; risk factors; equities; passive investments; indexing

Suggested Citation

Ung, Daniel and Luk, Priscilla and Kang, Xiaowei, Quality: A Distinct Equity Factor? (July 26, 2014). Available at SSRN: https://ssrn.com/abstract=2472391 or http://dx.doi.org/10.2139/ssrn.2472391

Daniel Ung (Contact Author)

CFA Institute ( email )

915 East High Street
Charlottesville, VA 22902
United States

Chartered Alternative Investment Analyst Association (CAIA) ( email )

Global Association of Risk Professionals ( email )

Priscilla Luk

S&P Dow Jones Indices ( email )

55 Water Street
New York, NY 10041
United States

Xiaowei Kang

Standard & Poor's ( email )

London EC2M 7NJ
United Kingdom

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