Interesting concept – we will just state caveat emptor…
In early June, State Street launched a series of foreign-equity SPDR exchange-traded funds tracking MSCI’s Quality Mix, or QM, indexes. The funds charge 0.30%, making them the cheapest or near cheapest options in their respective categories.
The QM index rides on the coattails of AQR researchers Andrea Frazzini, David Kabiller, and Lasse Pedersen’s paper “Buffett’s Alpha,” which argues that the returns of Buffett’s public equity portfolio, estimated from quarterly 13F filings, can be explained by exposure to value, quality, and low-volatility (or, more precisely, betting against beta) factors. While I don’t believe they’ve completely distilled Buffett’s essence into a set of mechanical rules, they’ve captured enough of it.
The QM index doesn’t replicate Frazzini et al.’s procedure; rather, it equal-weights MSCI’s Value Weighted, Quality, and Minimum Volatility indexes, rebalanced semiannually.
Here’s how each works:
The Value-Weighted Index weights each stock based on a composite of book, sales, earnings, and cash earnings. It’s a virtual clone of the Research Affiliates Fundamental Index.
The Quality Index scores each stock on return on equity, five-year earnings variability, and debt/equity ratio. Stocks with high ROE, low earnings variability, and low debt/equity are assigned higher scores, and the ones with the highest composite scores make the cut and are weighted by their composite scores multiplied by market cap.
The Minimum Volatility Index estimates the factor loadings of each stock and uses an optimizer with constraints to minimize portfolio volatility.
The fact that the QM index is nothing more than an equal-weight strategy of three existing MSCI factor indexes was probably a consideration in State Street’s not launching a U.S. QM fund. IShares already offers U.S. Value-Weighted, Quality, and Minimum Volatility ETFs for 0.15% each. State Street wouldn’t have been competitive.
With MSCI claiming intellectual lineage from Frazzini et al., I checked to see whether the MSCI USA Quality Mix Index exhibited loadings to the quality, value, and low-volatility factors as defined by the AQR researchers, using monthly returns from May 31, 1988, to March 30, 2012 (the latest date for which the betting against beta factor data is available).
