Quality Isn't Confined To The US, And This ETF Proves It

The quality factor was a star last year and received plenty of attention thanks in part to exchange traded funds, such as the iShares Edge MSCI USA Quality Factor ETF QUAL.

Like any other investment, the benefits of quality aren't confined to domestic assets. For example, QUAL has an often overlooked international counterpart – the iShares Edge MSCI Intl Quality Factor ETF IQLT that could prove to be a superior avenue for investors looking to add some ex-US exposure to their portfolios.

The $1.19 billion IQLT, which turned five years old last month, follows the MSCI World ex USA Sector Neutral Quality Index. That benchmark “measures the performance of large- and mid-capitalization developed international stocks as identified through three fundamental variables: return on equity, earnings variability and debt-to-equity,” according to iShares.

Why It's Important

Historical data confirm that IQLT's underlying index has outperformed the traditional MSCI World ex USA Index by a noticeable margin over the past several years.

“We observe that international quality has historically outperformed the broader market over time,” BlackRock said in a recent note. “In fact, international quality has outperformed the broader market by an annualized return of 1.9% with similar risk, providing investors not only with enhanced returns, but also with attractive risk-adjusted returns.”

With a domestic quality ETF, sector exposures matter. The same is true of a fund like IQLT, but geography matters, too. The U.K., Japan and Switzerland – three countries that offer quality traits – combine for 45% of IQLT's geographic exposure.

What's Next

Quality is often conflated with low volatility, a separate investment factor. One reason for that confusion may be downside and upside capture. However, quality has typically offered better upside capture and that's true with international quality, too.

“International quality’s lower downside capture demonstrates that international quality has historically outperformed in down markets – meaning that when the broader market posted a negative monthly return, the strategy declined less than the market,” according to BlackRock. “At the same time, the quality factor has historically participated in 99% of the upside indicating that the strategy has roughly kept pace with the broader market when the broader market posted a positive monthly return.”

And while quality is different than low volatility, IQLT's three-year standard deviation of 10.84% is 60 basis points below the comparable metric on the MSCI ACWI ex USA Index.

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