MSCI, a leading provider of financial market indices, has introduced the MSCI Quality Indices, a series of smart beta equity indices designed to represent the performance of a quality growth strategy.
The new series forms part of the MSCI Risk Premia suite of strategy indices. This suite includes the successful MSCI Minimum Volatility indices, which underlie a range of iShares exchange-traded funds (ETFs).
These latest indices are designed to identify quality growth companies; namely companies that typically exhibit high returns on equity, stable earnings that are uncorrelated with the broad business cycle, and strong balance sheets with low financial leverage.
The indices aim to capture these characteristics with an objective and transparent methodology, while ensuring reasonably high trading liquidity, investment capacity and moderate turnover of index constituents, which are important practical considerations for the real-world application of the strategy.
The initial roll-out of this series includes five indices:
The launch of this series further reflects the growing interest in ‘smart beta’.
Traditionally, portfolio returns were attributed to passive market exposure (equity risk premium), captured through conventional capitalisation-weighted indices, and active portfolio management. More recently, however, investors have realised that many return components that were once attributed to active management (‘alpha’) can actually be attributed to sources of systematic return (‘beta’) such as value, size, volatility, or momentum. This has led to the development of alternatively-weighted (i.e. non cap weighted) indices, broadly defined as smart beta.
“There has been a clear acceleration of demand for such indices from MSCI’s institutional investor clients, and increasing numbers of financial products are being launched based on risk premia categories,” said Baer Pettit, Managing Director and Global Head of the MSCI Index Business.
Ultimately, over time, the MSCI Quality Indices are likely to be licensed for use as benchmarks for quality growth strategies and as the basis for index-linked financial products such as ETFs. However, investors who find this kind of alternatively-weighted quality growth approach appealing needn’t necessarily wait for such a product to be launched. Reflective of the growing interest in smart beta, a number of ETFs already exist in this space – some of the most successful of which are sponsored by Invesco PowerShares.
PowerShares offers a range of alternatively-weighted ETFs, but the funds most similar to the new MSCI indices are based on FTSE RAFI Indices. The FTSE RAFI Index Series, which was co-developed by index provider FTSE and indexing and asset allocation specialists Research Affiliates, selects index constituents using four fundamental factors reflective of quality. The four fundamental factors are book value, income, sales and dividends. The stocks with the highest fundamental strength according to these factors are then weighted by their fundamental scores.
PowerShares has launched ETFs based on a whole host of these indices, covering the major countries and regions, and developed and emerging markets. They are listed on the London Stock Exchange, NYSE Arca, and Toronto Stock Exchange. Examples of their UK-listed funds include the PowerShares FTSE RAFI All-World 3000 ETF (PSRW), PowerShares FTSE RAFI Emerging Markets ETF (PSRM) and the PowerShares FTSE RAFI UK 100 ETF (PSRU) and PowerShares FTSE RAFI Europe ETF (PSRE).
Also offered by PowerShares in the US is the PowerShares S&P 500 High Quality Portfolio ETF (SPHQ). This NYSE Arca-listed fund is based on the S&P 500 High Quality Rankings Index. Similar in concept to the MSCI Quality Indices and FTSE RAFI Indices, this S&P index provides exposure to the constituents of the S&P 500 Index that are identified as high quality, as represented by a measure of long-term growth and stability of earnings and dividends.
MSCI, FTSE and S&P are not alone in offering alternatively-weighted smart beta indices; Stoxx and Russell are also active in this space, as are a handful of smaller index players such as Wilshire and boutique providers such as Sabrient and S-Network Global Indexes.