Quality firms outperform in times of volatility

Quality companies tend to outperform in weaker economic environments and during market turmoils and display lower drawdowns and quicker recoveries, according to a new study from exchange traded fund (ETF) provider VanEck. 

The study found that those firms, which demonstrated stable earnings growth, low debt and high return on equity, historically outperformed the market benchmark during the 2001 dot-com bubble, the 2007-08 Global Financial Crisis and during the European debt crises of 2010. 

“Our whitepaper reveals that quality companies have demonstrated outperformance during periods of economic slowdown, such as the period we are now in, and over the long-term,” Arian Neiron, VanEck's managing director and head of Asia Pacific, said. 

“Quality companies boast stable earnings that are uncorrelated with the broad business cycle, helping to explain their outperformance.” 

VanEck quoted research from the world’s largest index provider, MSCI, where MSCI World Quality Index outperformed the MSCI World Index in most economic conditions while its Quality Index had its strongest outperformance when economic growth was slowing and inflation was rising. 

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He explained that while quality companies were impacted by market events, they were typically hit less severely than the broader market and lost less and thanks to their cash flows they were more likely to survive a downturn than companies with high debt levels and low return on equity. 

“Importantly too, quality provides defence against volatile markets. When the CBOE Volatility Index, or VIX, is rising, Quality outperforms. This has never been truer than during the current crisis. During March 2020, the MSCI World Quality Index outperformed the MSCI World Index by 4.81% when the VIX soared.  

“Its drawdown was much less than for global share markets generally,” Neiron said.