Time for quality control

14 June 2023 by National Bank Investments
Chess game

Market uncertainties, increased volatility, and an economic slowdown have led many investors to rethink how they evaluate equities. In this context, quality factor investing has been gaining traction among professional money managers.

Understanding how quality factor works

In the world of investing, a factor corresponds to any characteristic that can help explain an asset’s long-term risk and return profile. Many characteristics come into play, including the asset’s value, momentum, size, or even quality. Stocks that are considered “quality” are generally comprised of companies that feature stable earnings, robust balance sheets, and consistent growth in comparison to lower quality stocks. During periods of market and economic uncertainties, quality companies can be less prone to interest rate risk because of their minor reliance on leverage. Given where the yield curve now stands and as capital becomes scarcer, money managers tend to prioritize these stocks which can be assessed by using Return on Equity (ROE) data.

Why quality now?

The current economic backdrop may prove favourable for quality. Historically, the quality factor tends to do well when economic growth slows, and long-term interest rates are on a downward trend. Both of these circumstances seem to be taking shape now. Empirical evidence shows that this has occurred in some of the most recent downturns, such as during the global financial crisis of 2008. (Rao, 2022) Indeed, as Chart 1 (below) illustrates, the quality factor has been one of the best performing and stable sources of equity alpha in the U.S. over the last 20 years.

U.S. Equity Factor – Cumulative Alpha (last 20 years)

Graphic U.S. Equity Factor vs Cumulative Alpha during the last 20 years

CIO Office (data via Refinitiv).

Furthermore, quality has become in vogue and has regained its luster since the beginning of this year. A trend that could continue as this supportive backdrop for quality stocks takes shape. (Chart 2)

U.S. quality factor performance vs manufacturing activity

Graphic U.S. quality factor performance vs manufacturing activity

CIO Office (data via Refinitiv).

Opportunity in quality

Quality companies are often better positioned to withstand declining economic environments. Companies with robust balance sheets, positive free cash flows, and sustained competitive advantages tend to be more resilient during these periods. Given the current landscape, exposure to high-quality stocks can potentially help investors weather uncertain market conditions over the long term.

Discover some of the NBI funds and ETFs with a quality factor exposure.

Legal notes

The information and opinions herein are provided for information purposes only and are subject to change without notice. The opinions are not intended as investment advice nor are they provided to promote any particular investments and should in no way form the basis for your investment decisions. National Bank Investments Inc. has taken the necessary measures to ensure the quality and accuracy of the information contained herein at the time of publication. It does not, however, guarantee that the information is accurate or complete, and this communication creates no legal or contractual obligation on the part of National Bank Investments Inc.

NBI Funds (the “Funds”) are offered by National Bank Investments Inc., a wholly owned subsidiary of National Bank of Canada. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus of the Funds before investing. The Funds’ securities are not insured by the Canada Deposit Insurance Corporation or by any other government deposit insurer. The Funds are not guaranteed, their values change frequently and past performance may not be repeated.NBI exchange-traded funds (the “NBI ETFs”) are offered by National Bank Investments Inc., a wholly owned subsidiary of National Bank of Canada. Management fees, brokerage fees and expenses all may be associated with investments in NBI ETFs. Please read the prospectus or ETF Facts document(s) before investing. NBI ETFs are not guaranteed, their values change frequently and past performance may not be repeated. NBI ETFs units are bought and sold at market price on a stock exchange and brokerage commissions will reduce returns. NBI ETFs do not seek to return any predetermined amount at maturity.This index provider is included in this document: BofA Merrill Lynch. This index provider is licensing its indices “as is”, makes no warranties regarding same, does not guarantee the suitability, quality, accuracy, timeliness and/or completeness of its indices or any data included in, related to or derived therefrom, assumes no liability in connection with its use and does not sponsor, endorse or recommend National Bank of Canada and its wholly owned subsidiaries or any of their products and services. The above index provider does not guarantee the accuracy of any index or blended benchmark model created by National Investment Bank using this index. No responsibility or liability shall attach to any member of the index provides or its respective directors, officers, employees, partners or licensors for any errors or losses arising from the use of this publication or any information or data contained herein. In no event shall the above index provider be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, legal or other expenses, or losses (including, without limitation, lost revenues or profits and opportunity costs) arising out of or in connection with the use of the content, even if advised of the possibility of such damages.

BofA indices are trademarks of Merrill Lynch, Pierce Fenner & Smith incorporated (“BofAML”).

© 2023 National Bank Investments Inc. All rights reserved. Any reproduction, in whole or in part, is strictly prohibited without the prior written consent of National Bank Investments Inc.


Investor Education

Get informed with investor education content.


Learn more