By Holly Framsted, Head of US Factor ETFs within BlackRock’s ETF and Index Investment Group.

Holly Framsted, Head of US Factor ETFs within BlackRock’s ETF and Index Investment Group.

Uncertainty is keeping many investors within their home borders. Investing in the quality factor may help them access international opportunities while building portfolio resilience.

On an almost daily basis, mainstream and financial news inundate us with reminders of geopolitical and economic uncertainties roiling the world. Investors are ever more confused about the potential impacts of these upheavals on their portfolios.

As a result, many investors, perhaps inadvertently, have become even more entrenched in home-country biases. In fact, a recent study (by my colleagues Andrew Ang and Patrick Nolan) analyzed nearly 10,000 portfolios and observed that investors chronically overweight US equities and lack meaningful factor tilts in their portfolios.

Source: BlackRock.

Yet, by shunning international markets and factors, investors are missing out on a potential diversifier in their portfolios, and an opportunity for long-term growth potential and added portfolio resilience.

Diversified quality exposure to international markets

One way to access international markets while navigating geopolitical and economic unknowns is by investing in a diversified group of high-quality companies via the quality factor. Investing in the quality factor offers above-average exposure to these highly profitable companies with stable earnings and low indebtedness.

The quality factor has also historically been more resilient in challenging market environments while still providing much-needed upside market participation. Given prospects for a slowing or weakening global economy, the quality factor may be an attractive investment strategy for deploying capital in international markets.

The iShares Edge MSCI Intl Quality Factor ETF (IQLT US) is one quality strategy that provides investors with diversified, efficient access to international markets. The strategy seeks to track the MSCI World ex USA Sector Neutral Quality Index which selects companies with high return on equity (ROE), low leverage, and low earnings variability, while still providing diversification across sectors and countries.

Enhanced return potential

In addition to seeking diversification, investors may also deploy an international quality strategy for the potential to enhance investment returns over time. After all, the quality factor, in addition to the value, low size, and momentum factors, is a potentially return-enhancing factor and may be deployed within a portfolio to seek outperformance over the broader market.

We observe that international quality has historically outperformed the broader market over time in the chart below. In fact, international quality has outperformed the broader market by an annualized return of 1.9% with similar risk, providing investors not only with enhanced returns but also with attractive risk-adjusted returns.

Source: BlackRock.

Resiliency for uncertain markets

Interestingly, the quality factor has historically sourced much of its long-term out-performance from its resilient characteristics. To better understand the factor’s behavior, we observe the performance of international quality in both positive and negative markets using upside and downside capture ratios.

International quality’s lower downside capture demonstrates that international quality has historically outperformed in down markets – meaning that when the broader market posted a negative monthly return, the strategy declined less than the market. At the same time, the quality factor has historically participated in 99% of the upside indicating that the strategy has roughly kept pace with the broader market when the broader market posted a positive monthly return.

Overall, this observation confirms that international quality has historically derived much of its outperformance through its ability to provide investors with much-needed outperformance in periods of market stress and demonstrates the factor’s resilience.

Source: BlackRock.

Quality for the long-term

In a slow-growth, uncertain political environment, investing internationally can be challenging even for the most experienced investors. Factors like Quality may offer a diversified and efficient way to capitalize on potential opportunities outside one’s home market while also building resilience into a portfolio in the event of future bumps in the road. As such, deploying an international quality strategy may be appropriate for investors aiming to diversify their portfolios amid market uncertainty.

The author would like to thank Elizabeth Turner, Vice President, and Omar Karhani, Associate for their contributions to this post.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)