mixmotive
By Wenli Bill Hao
As investments in artificial intelligence continue to boom, major indices in the U.S., Europe and Japan have hit all-time highs. In our previous blog, we reviewed how the S&P U.S. Quality Indices outperformed their corresponding benchmarks over both the short and the long term. Similarly, a quality premium also exists in developed ex-U.S. equity markets. As shown in Exhibit 1, for the one-year period from Jan. 31, 2023, to Jan. 31, 2024, the S&P Quality Developed Ex-U.S. LargeMidCap outperformed its benchmark by a decent margin. In this blog, we investigate the index’s design, performance, characteristics and attribution.
Quality Metrics and Index Design
The S&P Quality Developed Ex-U.S. LargeMidCap utilizes the same three prominent metrics as the S&P U.S. Quality Indices. These metrics aim to capture a company’s quality characteristics: strong profitability, high earnings quality and robust financial strength (see Exhibit 2). The index constituents correspond to the top 20% of eligible stocks within the S&P Developed Ex-U.S. LargeMidCap’s universe, ranked by their overall quality scores. These constituents are weighted by the product of their market capitalization and quality scores, subject to country (maximum 40%), sector (maximum 40%) and individual (maximum 5%) holding constraints.1
Performance Comparison
Historically, the S&P Quality Developed Ex-U.S. LargeMidCap has outperformed its benchmark over the short and the long term with respect to total return and risk-adjusted return (see Exhibit 3). Additionally, the quality strategy has tended to exhibit defensive qualities, as evidenced by lower beta and smaller drawdowns.
From its launch on July 8, 2014, to Jan. 31, 2024, the S&P Quality Developed Ex-U.S. LargeMidCap had a cumulative return of 71.19% (with an annualized volatility of 14.3%) versus a cumulative return of 51.87% (with an annualized volatility of 14.2%) for its benchmark. The outperformance of 19.32% was mainly from the top five contributors that were largely from the Information Technology and Health Care sectors (see Exhibit 4).
High Upside Participation and Defensive Characteristics
The historical capture ratios in Exhibit 5 show that the S&P Quality Developed Ex-U.S. LargeMidCap tended to participate one-for-one in up markets,2 while delivering significant outperformance during down markets. Such features held true for the whole period since the index inception date and post-launch period. These unique characteristics make sense since quality indices are designed to track companies with durable business models and sustainable competitive advantages.
Country Exposure
In Exhibit 6, we investigate the country allocation of the constituents in the S&P Quality Developed Ex-U.S. LargeMidCap and its benchmark. From Dec. 17, 1999, to Jan. 31, 2024, the index mainly overweighted Switzerland (6.68%) and the U.K. (5.71%) while underweighting Japan (-9.00%) and Germany (-2.15%).
Sector Exposure
We next explore the sector exposure of the S&P Quality Developed Ex-U.S. LargeMidCap. As seen in Exhibit 7, the index historically has had a significant overweight in Health Care (10.02%) relative to its benchmark, with a large underweight in Financials (-14.74%).
Factor Exposure
Exhibit 8 shows the factor exposure of the S&P Quality Developed Ex-U.S. LargeMidCap versus its benchmark in terms of the Axioma World-Wide Ex-US Risk Model3 Factor Z-scores. The quality index demonstrated strong quality and growth tilts versus its benchmark. Specifically, the quality index had lower exposures to leverage ratio and value factors, with a higher exposure to growth than its benchmark.
1 For further information about the factor definition, factor score calculation and index design, please see the S&P Quality Indices Methodology.
2 The market is defined as the monthly performance of the underlying benchmark from Dec. 31, 1994, to July 31, 2023.
3 The Axioma World-Wide Ex-US Equity Factor Risk Model does not have a style factor for profitability.
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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
