Clifford Asness AQR Capital Management, LLC has a new white paper out titled Quality Minus Junk, which examines taking long positions in quality minus junk stocks and shorting low quality stocks.
Check out a brief description followed by the full document:
We define a quality security as one that has characteristics that, all-else-equal, an investor should be willing to pay a higher price for: stocks that are safe, profitable, growing, and well managed. High-quality stocks do have higher prices on average, but not by a very large margin. Perhaps because of this puzzlingly modest impact of quality on price, high-quality stocks have high risk-adjusted returns. Indeed, a quality-minus-junk (QMJ) factor that goes long high-quality stocks and shorts low-quality stocks earns significant risk-adjusted returns in the U.S. and globally across 24 countries. The price of quality – i.e., how much investors pay extra for higher quality stocks – varies over time, reaching a low during the internet bubble. Further, a low price of quality predicts a high future return of QMJ.
H/T Floating Path
When did our field stop being “asset pricing” and become “asset expected returning?” … Market-to-book ratios should be our left-hand variable, the thing we are trying to explain, not a sorting characteristic for expected returns.
– Cochrane, Presidential Address, American Finance Association, 2011
The asset pricing literature in financial economics studies the drivers of returns, but, while linked, the economic consequences of market efficiency ultimately depend on prices, not returns, as emphasized by Summers (1986) and Cochrane (2011). Do the highest quality firms command the highest price so that these firms can finance their operations and invest? To address this question, we define quality as characteristics that investors should be willing to pay a higher price for, everything else equal. We show that quality is priced, that is, investors pay more for firms with higher quality characteristics.