Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
"Quality investing is an enigma. Few, if any, investment strategies increase return without increasing (or even cutting) risk. But the quality factor has done just that over the past decade."
"Higher return without higher risk is counterintuitive and undermines economic theory in finance textbooks. What’s more puzzling is that there’s no universally accepted definition of quality or consensus on which metrics best identify it."
The Other Side of Value:The Gross Profitability Premium Robert Novy-Marx June, 2012
Abstract
Profitability, measured by gross profits-to-assets, has roughly the same power as book-to-market predicting the cross-section of average returns. Profitable firms generate significantly higher returns than unprofitable firms, despite having significantly higher valuation ratios. Controlling for profitability also dramatically increases the performance of value strategies, especially among the largest, most liquid stocks. These results are difficult to reconcile with popular explanations of the value premium, as profitable firms are less prone to distress, have longer cash flow durations, and have lower levels of operating leverage. Controlling for gross profitability explains most earnings related anomalies, and a wide range of seemingly unrelated profitable trading strategies.
After a quick review, I would hazard that the funds mentioned are not inexpensive.
It also seems to me that, at least, some of the factors mentioned are available in MFO Premium. So one could search for funds that don't specifically mention quality in their name. What fun.
A key concern with generic quality strategies is that they use poor definitions, which are sometimes even blended with other factors. For example, quality is often measured by financial leverage or earnings stability, which are actually more related to the low volatility factor. Other quality definitions – such as growth in profitability or earnings growth, but also an oft-used measure like return on equity (ROE) – have weak or no predictive power for future returns.
As shown in Figure 7, our research 9 also shows that measures based on academic studies (blue bars) outperform industry-based measures (magenta bars) in global markets. ‘Academic’ measures are accruals, gross profitability and net stock issues, while ‘industry’ measures include ROE, margins, ROE growth, leverage, and earnings variability.
Fund companies define quality inconsistently using different measures. Obviously, this can be problematic. Larry Swedroe references a paper which differentiates between academic and industry definitions for quality investing.
Fund companies define quality inconsistently using different measures. Obviously, this can be problematic. Larry Swedroe references a paper which differentiates between academic and industry definitions for quality investing.
Swedroe references the same article as the Robeco people.
One finds lots of academic papers on funds and accrual strategies, but I find very few references to funds actually looking at accrual strategies, besides the quality funds from Invesco.
Mutual Fund Premium does not track any of the academic definitions, so far as I can tell.
StockRover includes a Novy-Marx Quality screener and Sloan Ratio metrics. Unfortunately, both can only be used for stocks and are not applicable for ETFs. I don't know how to screen mutual funds/ETFs for academics' quality measures or if this is even possible.
Novy-Marx Quality It looks for quality as measured by gross profits over total assets, momentum as measured by 1 year price change and value as measured by low price to book ratios. This screener also filters out stocks with very low market caps and trading volumes.
Sloan Ratio The Sloan Ratio identifies companies with high accrual ratios, or high non-cash income or expenses. Sloan found that over a 40 year period buying low accrual companies and shorting high accrual ones generated a return of more than twice the S&P 500. The ratio is computed by subtracting operating and investment cash flow from net income and dividing by total assets. If the result is between -10% and 10% the company is in the safe zone but if the result is greater than 25% or less than -25% earnings are likely to be made up of accruals. Accruals that continue across several quarters are a signal for doctored earnings.
JQUA outperformed SPHQ, QUAL, and VFIAX on an absolute and risk-adjusted basis from Dec. 2017 - Jan. 2025. The time period was constrained by available data for JQUA.
Comments
Robert Novy-Marx
June, 2012
Abstract
Profitability, measured by gross profits-to-assets, has roughly the same power
as book-to-market predicting the cross-section of average returns. Profitable
firms generate significantly higher returns than unprofitable firms, despite having
significantly higher valuation ratios. Controlling for profitability also dramatically
increases the performance of value strategies, especially among the largest, most liquid
stocks. These results are difficult to reconcile with popular explanations of the value
premium, as profitable firms are less prone to distress, have longer cash flow durations,
and have lower levels of operating leverage. Controlling for gross profitability explains
most earnings related anomalies, and a wide range of seemingly unrelated profitable
trading strategies.
After a quick review, I would hazard that the funds mentioned are not inexpensive.
It also seems to me that, at least, some of the factors mentioned are available in MFO Premium. So one could search for funds that don't specifically mention quality in their name. What fun.
But they're not overly expensive.
FQAL - 0.16%
QUAL - 0.15%
SPHQ - 0.15%
JQUA - 0.12%
The funds' P/E and P/B data is below.
I didn't search for P/S or P/CF data.
Valuation Metrics - 12/31/2024
FQAL - 27.93 P/E; 6.65 P/B
QUAL - 29.31 P/E; 8.90 P/B
SPHQ - 29.68 P/E; 17.14 P/B
JQUA - 22.89 P/E; 5.53 P/B (1/31/2025 data)
IWB - 28.45 P/E; 4.82 P/B (iShares Russell 1000 etf for reference)
Obviously, this can be problematic.
Larry Swedroe references a paper which differentiates between academic
and industry definitions for quality investing.
https://www.etf.com/sections/index-investor-corner/swedroe-differing-definitions-quality
One finds lots of academic papers on funds and accrual strategies, but I find very few references to funds actually looking at accrual strategies, besides the quality funds from Invesco.
Mutual Fund Premium does not track any of the academic definitions, so far as I can tell.
Unfortunately, both can only be used for stocks and are not applicable for ETFs.
I don't know how to screen mutual funds/ETFs for academics' quality measures or if this is even possible.
Novy-Marx Quality
It looks for quality as measured by gross profits over total assets, momentum as measured by 1 year price change and value as measured by low price to book ratios.
This screener also filters out stocks with very low market caps and trading volumes.
Sloan Ratio
The Sloan Ratio identifies companies with high accrual ratios, or high non-cash income or expenses.
Sloan found that over a 40 year period buying low accrual companies and shorting high accrual ones generated a return of more than twice the S&P 500. The ratio is computed by subtracting operating and investment cash flow from net income and dividing by total assets. If the result is between -10% and 10%
the company is in the safe zone but if the result is greater than 25% or less than -25% earnings are likely
to be made up of accruals. Accruals that continue across several quarters are a signal for doctored earnings.
I learned about it HERE first maybe ... 4y ago? 3y?
from Dec. 2017 - Jan. 2025. The time period was constrained by available data for JQUA.
https://www.portfoliovisualizer.com/backtest-portfolio?s=y&sl=1h6EglHoYVwvNJlJYjcA56