Revisiting Quality Investing

93 Pages Posted: 14 Jul 2021 Last revised: 11 Nov 2021

See all articles by Frederic Lepetit

Frederic Lepetit

Amundi Asset Management

Amina Cherief

Amundi Institute

Yannick Ly

Amundi Asset Management

Takaya Sekine

Amundi Institute

Date Written: June 30, 2021

Abstract

In the field of factor investing, quality is undoubtedly the equity factor with the weakest consensus. This research investigates the best way to define it. In order to capture the multi-faceted reality of the factor depicted in academia, we address the quality factor through a multidimensional process by defining four self-reliant pillars: profitability, earnings quality, safety and investment. To better fit institutional investor's' needs, we analyze the resulting factor by focusing on the last eighteen years and on a global developed markets universe of liquid stocks (large- and mid-caps).

In a long-short framework, our quality factor delivers a statistically significant alpha that cannot be explained by loadings on conventional equity factors (market, value, size and momentum). Most regions and dimensions display positive contribution to this alpha, with the noticeable exceptions of the Eurozone region and the safety dimension. In a long-only framework, our quality factor outperforms its benchmark by 2.8% per annum over the entire analysis period, with an information ratio of 0.81. Furthermore, the outperformance has been very consistent since the 2008 Global Financial Crisis (GFC). The four dimensions are weakly correlated with each other and are therefore complementary. We show that safety is of particular importance during periods of market turmoil (GFC, Covid-19 pandemic) and that the dimension is therefore part of the quality factor in its own right. On the Eurozone side, a sector-neutral portfolio construction seems to be more suited.

We also introduce a new portfolio construction methodology by implementing a clustering approach based on the K-means algorithm to group together companies based on features that are related to both fundamentals and market characteristics. This approach allows to capture dynamic variations between fundamentals and other stock features. This fully implementable process results in better quality factor performance without impacting the associated risk measures or the portfolio’s quality exposure, as measured on the unconstrained quality factor.

Keywords: Quality, Factor investing, Profitability, Earnings quality, Accruals, Safety, Capital structure, Investment, Asset pricing, Clustering, K-Means algorithm, Gaussian Mixture Models, Covid-19, Global Financial Crisis

JEL Classification: C30, G11, G12

Suggested Citation

Lepetit, Frederic and Cherief, Amina and Ly, Yannick and Sekine, Takaya, Revisiting Quality Investing (June 30, 2021). Available at SSRN: https://ssrn.com/abstract=3877161 or http://dx.doi.org/10.2139/ssrn.3877161

Frederic Lepetit (Contact Author)

Amundi Asset Management ( email )

90 Boulevard Pasteur
Paris, 75015
France

Amina Cherief

Amundi Institute ( email )

90 Boulevard Pasteur
Paris, 75015
France

Yannick Ly

Amundi Asset Management ( email )

90 Boulevard Pasteur
Paris, 75015
France

Takaya Sekine

Amundi Institute ( email )

90 Boulevard Pasteur
Paris, 75015
France

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