Benefits of Quality Apparent During Volatile Q3

Global Head of Research

We’ve written a lot recently about what it means to focus on quality in equity investments. The third quarter of 2015—with the volatility that it brought along with it—provided what we think was an interesting short period to illustrate the benefits of a quality approach.   Bottom Line: Quality as a factor has historically worked best during volatile periods, and this third quarter was a prime example.1 MSCI EAFE Quality (EAFE Quality) and EAFE (EAFE Broad) Indexes, both measured in local currency terms, illustrate over a long period of analysis how this played out across time—back to December 1, 1975. We looked at rolling periods three months, six months, 12 months and 36 months in duration. Importantly, we focused our analysis on times when EAFE Broad exhibited a negative return, zeroing in on periods where performance was a bit more challenging, like what we saw in the third quarter of 2015. We also looked at median returns for these different periods, so as to mitigate the risk of outliers influencing the picture.   Median Performance in Down Markets over Specified Rolling (3-, 6-, 12- & 36-Month) Periods from 12/1/1975 to 9/30/2015 Median Performance At a high level, based on what we see in the chart, there was median outperformance of EAFE Quality over EAFE Broad over each of the rolling period frequencies—3, 6, 12 and 36 months—when the return of EAFE Broad was negative.   • Big Declines of 5% or More: Digging a little deeper into the three-month analysis, since we began our focus talking about the third quarter of 2015, there were actually 70 three-month periods from December 1, 1975, to September 30, 2015, in which the returns for the MSCI EAFE Index declined more than 5%. • Median outperformance of EAFE Quality in those periods was approximately 3%, while in all other periods the median differential was essentially zero. • Looking again a bit further at the rolling three-month analysis, there were 126 three-month periods in which returns for EAFE Broad declined more than 1%. Median outperformance of quality in those periods was close to 2 percentage points, while in all other rolling three-month periods, the median differential was negative 18 basis points (bps) , meaning that EAFE broad slightly outperformed EAFE Quality during positive environments. • This research suggests quality as a factor had some of its best returns for the EAFE universe during down markets, declining less than EAFE Broad. The Third Quarter of 2015 Now that we know our expectations of how quality might perform in difficult markets, it’s time to look at the third quarter of 2015. Importantly, the WisdomTree International Hedged Quality Dividend Growth Fund (IHDG) tracks the performance of the WisdomTree International Hedged Quality Dividend Growth Index before fees and expenses. This Index represents WisdomTree’s approach to quality in the developed international equities. Zooming In on the Third Quarter and Year-to-Date Periods of 2015 (as of September 30, 2015) 3rd Quarter and YTD Periods of 2015 Average Annual Returns as of September 30, 2015 Untitled-7 • In Q3, the EAFE Broad was down nearly 9%, but IHDG was down merely 4.8%. This is approximately 4.2% outperformance. EAFE Quality also outperformed EAFE Broad by more than 5 percentage points. Median outperformance of EAFE Quality over EAFE Broad when EAFE Broad was negative was closer to 1.5%, so this represents a significant period, in our view. • Broadening to the year-to-date 2015 period, we see that EAFE Broad delivered a negative return of nearly 1.0%. EAFE Quality was up 2.0%, and IHDG was up nearly 4.1% over this same time frame. While we recognize that this was just one single three-month period (as well as one single year-to-date nine-month period), we still believe it to be worth noting. If people think markets could continue to exhibit volatility similar to what was seen in the third quarter of 2015, we think that looking toward quality should be of particular interest.         1Source: Bloomberg, as of 9/30/15.

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About the Contributor
Global Head of Research

Christopher Gannatti began at WisdomTree as a Research Analyst in December 2010, working directly with Jeremy Schwartz, CFA®, Director of Research. In January of 2014, he was promoted to Associate Director of Research where he was responsible to lead different groups of analysts and strategists within the broader Research team at WisdomTree. In February of 2018, Christopher was promoted to Head of Research, Europe, where he was based out of WisdomTree’s London office and was responsible for the full WisdomTree research effort within the European market, as well as supporting the UCITs platform globally. In November 2021, Christopher was promoted to Global Head of Research, now responsible for numerous communications on investment strategy globally, particularly in the thematic equity space. Christopher came to WisdomTree from Lord Abbett, where he worked for four and a half years as a Regional Consultant. He received his MBA in Quantitative Finance, Accounting, and Economics from NYU’s Stern School of Business in 2010, and he received his bachelor’s degree from Colgate University in Economics in 2006. Christopher is a holder of the Chartered Financial Analyst Designation.