Global Allocation Insight

Why quality matters in today’s markets

Apr 20, 2018

Market volatility has increased relative to recent years. Holding high quality companies could make a difference.

Although market volatility has retreated from its unprecedented February spike, it has not abated to the low levels that investors had become accustomed to over the past couple of years. The VIX Index, which measures the implied volatility of the S&P 500 Index, is now hovering near 20 – double its January low. This implies that investors expect twice as much near-term volatility as they did earlier this year. Assuming we continue to experience episodic spikes in volatility, investors may want to consider adding more high quality companies to their portfolio.

What constitutes “quality” in a company? And why is it particularly appealing in today’s markets? While there is no exact definition, quality typically refers to some combination of high profitability, a low debt-to-equity ratio, and earnings consistency. In aggregate, shares of companies with these characteristics offer the potential to outperform the broader market over the long term. Over the past ten years, the MSCI USA Quality Index has beaten the broader MSCI USA Index by approximately 0.16% per month on average. Moreover, quality stocks have exhibited a tendency to outperform when volatility rises.

The chart below illustrates that higher levels of volatility, represented by the VIX Index, have typically corresponded with the outperformance of quality stocks, i.e., where the line representing the relative performance of the MSCI USA Quality Index versus the MSCI USA Index increases.

Quality stocks have outperformed when volatility increased

Quality stocks have outperformed when volatility increased

CBOE VIX Index sourced from Bloomberg, MSCI Index data sourced from Thomson Reuters, April 2018. The MSCI USA Quality Index is comprised of 125 stocks in the MSCI USA Index that have high quality scores based on return-on-equity, earnings growth and financial leverage. The MSCI USA Index measures the performance of more than 600 large and mid cap U.S. stocks, representing roughly 85% of the free float-adjusted U.S. market capitalization. The relative performance of the MSCI Indexes as illustrated in the chart above is rebased to 100. Total return indices were used for the MSCI Index data.

We believe equity market volatility is likely to remain elevated relative to recent years. In the Global Allocation Fund, we have increased exposure to quality companies with stable cash flows in more defensive sectors, particularly within healthcare and consumer staples, where demand tends to be more inelastic and may be able to withstand increased market volatility.

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Russ Koesterich
Portfolio Manager, Global Allocation
Russ Koesterich, CFA, JD, Managing Director and portfolio manager, is a member of the Global Allocation team within BlackRock's Multi-Asset Strategies Group. He ...
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