• Vector Insights

    Quality for quITALY

    Russel Chesler, Director, Investments & Portfolio Strategy
    15 June 2018

    Driven by new fears of an Italian debt default and European Union (EU) breakup, equity markets were volatile in May. In Italy the populist parties from the left and right have formed a coalition government that may promote initiatives that would enable Italy to exit the euro and would likely drive the country further into fiscal problems. Initially, Italian President Sergio Mattarella blocked the coalition, which effectively suspended their plans. A subsequent compromise was reached, but political instability should keep the markets on edge for the foreseeable future.

    Already, Italy’s debt is the second greatest in the EU at around 132% of GDP. Only Greece’s is greater – at around 180% of GDP – but Greece doesn’t matter as much since its economy is so much smaller and it doesn’t issue anywhere near as much debt as Italy, where government debt is estimated around 2.3 trillion euro, according to Reuters.1 But remember it was Greece that triggered the last crisis. The concern therefore is that Italy could trigger a much broader and deeper catastrophe.

    History has persistently shown that in times of volatility, quality companies have outperformed and when markets fall, quality companies lose less and recover faster. During the 2011 to 2012 European debt crisis and the three most recent periods of increased volatility, quality has outperformed the benchmark Australian investors use for international equities. In the graphs below when the green line is rising, quality is outperforming. You can see that during 2011 to 2012 when the market feared that Portugal, Ireland, Italy, Greece or Spain (PIIGS) would default, quality outperformed.


    Italian yield spike revives classic “risk off” mode

    The fears about the contagion of a European economy collapsing came to the fore in May. Investors remain concerned that Italy will become victim to a populist ruling coalition setting the stage for another European debt crisis. Both 2- and 10-year Italian bond yields have recently spiked to levels not seen for several years.

    Source: Bloomberg

    With another general election in Italy possibly on the cards following the recent one in March, investors’ concerns of another Euro exit or a repeat of the debt crisis is leading to increased volatility in markets.

    In 2015 when volatility was increasing to levels not previously seen since the 2011 to 2012 debt crisis, MSCI, one of the world’s largest index providers, released a research paper entitled Flight to Quality: Understanding Factor Investing which evaluated the use of 'Quality' as a factor in quantitative stock selection. The paper assessed the performance of this factor and its risk against other factors and the broad global equity market.

    Cutting through MSCI's thorough analysis, the conclusions of the paper were simple:

    1. Quality outperforms over the long term;
    2. The Quality factor provides diversification benefits; and
    3. During volatile periods and when there is a 'flight to quality', the Quality factor outperforms due to its defensive characteristics.

    The research, consistent with previous research, highlighted here, demonstrates that Quality has outperformed in periods that have the characteristics of current global markets, namely periods of heightened volatility.

    Converting this research into an investment opportunity has been difficult for Australian investors given the highest Quality companies identified by MSCI are foreign ones. Traditionally, Australian investors have had to rely on expensive active fund managers to identify Quality companies, achieving varying degrees of success.

    A solution exists which allows investors to access a portfolio of international companies selected by reference to a rules-based strategy that has historically outperformed in periods of volatility. Via a single trade on ASX, the VanEck Vectors MSCI World ex Australia Quality ETF (ASX: QUAL) provides investors with a cost effective portfolio of ~300 quality international companies identified by MSCI.

    QUAL aims to capture the performance of international Quality stocks selected by identifying companies with high quality scores based on three key fundamental financial measures: high return on equity; stable year-on-year earnings growth; and low financial leverage.

    QUAL may suit investors seeking international equity opportunities but are concerned of another European crisis or market volatility generally.

    For more information on QUAL – click here or speak to your adviser.


    IMPORTANT NOTICE: This information is issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck’) as responsible entity and issuer of the VanEck Vectors MSCI World ex Australia Quality ETF (‘QUAL’). Nothing in this content is a solicitation to buy or an offer to sell shares of any investment in any jurisdiction including where the offer or solicitation would be unlawful under the securities laws of such jurisdiction. This is general information only and not financial advice. It is intended for use by financial services professionals only. This is general information only and not financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Before making an investment decision in relation to the fund, you should read the PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. The PDS is available at www.vaneck.com.au or by calling 1300 68 38 37. QUAL is subject to investment risk, including possible loss of capital invested. QUAL invests in international markets. An investment in QUAL has specific and heightened risks that are in addition to the typical risks associated with investing in the Australian market. These include currency risks from foreign exchange fluctuations, ASX trading time differences and changes in foreign laws and regulations including taxation. Past performance is not a reliable indicator of future performance. No member of the VanEck group of companies gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance, or any particular rate of return from the fund. QUAL is indexed to a MSCI index. QUAL is not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to QUAL or the MSCI Index. The PDS contains a more detailed description of the limited relationship MSCI has with VanEck and QUAL.