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Vaneck’s QUAL and QHAL put quality at the forefront

When Vaneck recently launched the currency hedged version (QHAL) of the Veneck Vectors MSCI World ex Australia Quality ETF (QUAL), we thought it timely to take a look at the strategy and its points of difference.
Today we take a look at what ‘Quality’ really means.

By ETF Watch - Apr 07, 2019

When Vaneck recently launched the currency hedged version (QHAL) of the Veneck Vectors MSCI World ex Australia Quality ETF (QUAL), we thought it timely to take a look at the strategy and its points of difference.

At $530m in size, QUAL is one of only 24 ETFs with over $500m in market capitalisation and represents Vaneck’s second largest ETF. Below we take a look at the strategy that QUAL and QHAL employ.

What is QUAL and QHAL’s investment strategy?

QUAL and QHAL follow the MSCI World ex Australia Quality Index. This index is based on the standard market capitalisation weighted MSCI World ex Australia Index, however has a subtle difference, being the “Quality” in the name.

The Quality index aims to capture the performance of the highest quality growth stocks from the parent index, based on a quality score determined by three key factors:

  1. High return on equity;
  2. Stable year-on-year earnings growth; and
  3. Low financial leverage.

The quality index re-weights the selected quality growth stocks from the parent index, emphasising those stocks with the highest scores based on the above rules.

QUAL and QHAL are classic ‘Smart Beta’ ETFs, where companies are included not just based on their size, but also based on some qualitative factors. The theory being that this qualitative overlay will provide better performance over the long term.

What investments do QUAL and QHAL hold?

QUAL and QHAL hold roughly 300 companies, with around 70% of the portfolio including US based companies.

The top 10 includes familiar names of Microsoft, Apple, Facebook, Johnson and Johnson, Visa and Alphabet (Google). The largest holding (Microsoft) makes up 5% of the portfolio, with the top 10 providing 30% of underlying holdings.

Comparing QUAL and QHAL to a traditional market cap weighted global ETF, Vanguard’s MSCI Index International Shares ETF (VGS) which track’s QUAL and QHAL’s parent index the MSCI World ex Australia Index, the top 10 is fairly similar, but with some subtle differences:

The top 10 holdings of the parent index (VGS) represents 15% of the total portfolio, at 30%, QUAL an QHAL provide higher concentration at the top end of the portfolio. Whilst there is consistency amongst the Tech stocks at the top of the portfolio, beyond that the likes of JP Morgan Chase and Exxon Mobil are excluded from the top of the QUAL index.

This top ten leads to a higher weighting to technology stocks within QUAL of around 30%, compared to 15% for VGS. Additionally, QUAL’s portfolio is limited to 300 companies, with VGS investing in around 1,500 companies.

Below the difference in sector allocation across the two ETFs is demonstrated:

It can be seen that not only does QUAL/QHAG have over twice the allocation to tech companies, but also have higher exposure to health care and lower exposure to financials, energy, materials, utilities and real estate.

Interestingly QUAL and QHAG’s ‘quality’ overlay provides a sector allocation very similar to an ethical ETF who tend to be overweight tech and healthcare and underweight financials, energy and materials.

How has QUAL performed?

Now we’ve had a good look about QUAL’s points of difference, with these Smart Beta strategies, the question is, does the Smart Beta overlay result in better performance than a traditional index weighted ETF? We look below.

QUAL has been available on the ASX since October 2014. Whilst we’d prefer a full business cycle of ¬10 years to compare performance, 4 years at least gives a reasonable timeframe to compare QUAL’s performance.

Below we have compared QUAL to Vanguard’s MSCI Index International Series ETF (VGS), which as we previously mentioned is the parent index that QUAL’s ‘Quality’ index is based on. We’ve also included iShares Global 100 ETF (IOO), the largest global ETF available on the ASX at over $1.5b in size, investing in 100 of the world’s largest companies.

Performance assumes reinvestment of all dividends, with a starting balance of $1,000 in November 2014.

It can be seen QUAL (the blue line) has in fact performed better than VGS and IOO, with $1,000 invested in November 2014 now worth around $100 more than VGS and IOO. This has been a period where technology companies have had significant outperformance which would have helped QUAL, with its high exposure to technology companies. Interestingly MSCI indicate that the quality index best performs during weaker economic periods.

Time will tell if this outperformance can be maintained over the long term, however research from Vaneck shows outperformance of the index from 1994 to 2015. Note that this does not include any of the management costs associated with ETFs.

Source: Vaneck Whitepaper – International Equity Investing: The long term case for quality

What’s the difference between QUAL and QHAL?

Whilst QUAL has been around since 2014, QHAL has only recently been launched. QHAL employs the same strategy as QUAL, however is currency hedged back to Australian dollars. This means fluctuations in the Australian / US Dollar exchange rate will not impact QHAL’s performance.

QUAL and QHAL have management costs of 0.40% and 0.43% pa respectively.

Should you invest in QUAL and QHAL?

QUAL certainly has shown a history of strong performance, proving that in the past the strategy has been a profitable one for investors. The question with all Smart Beta strategies is, is what has happened in the past indicative of what will happen in the future, and is the additional management costs worth paying for? We’ll leave that one for investors to decide, but with over $500m under management, plenty of others obviously think so.

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