Curated Portfolio | XC Quant: Quality

By Kaushik Sanghani (kaushik.sanghani@xumitcapital.com)

Previously, we have launched XC Quant: Valuation, XC Quant Dividends and XC Quant: Growth. These multifactor portfolios beat the market with high margins in a particular thematic way. In this article, we will understand the Quality theme, how to identify, and the performance of one quality portfolio, which handsomely beat the benchmark and found from thousands of different portfolio criteria.

Quality Factor Investing:

Most of us understand that we should invest in quality companies or say good ones. Because these are the companies that tend to be highly profitable, have a moat around the business, have a low debt structure and show growth. These are the companies which are known as good companies. NIFTY 200 Quality 30 Index includes ITC, Nestle, Infosys, TCS, and HCL. These are the top known companies in India, which are profitable and have a significantly less debt structure.

Quality seems like an abstract concept because how do you define it objectively? If we think of valuation, profitability or growth, we can have an objective portfolio out of these three. Let’s identify the companies at a low valuation, say making the profits more than others or showing growth in a particular industry. Still, when we define quality, we will have many perspectives like good brand name, robustness in their financial statements, low debt, growth, etc. Quality factor aims to capture the high return from the good companies. As seen above, NIFTY 200 Quality 30 chooses companies from quality scores based on ROE, debt structure and EPS growth. Can we make a better portfolio that gives more returns and still decides on quality companies? We have done that and now let’s discuss statistics and methodology around this portfolio.

Methodology:

Firstly, we have analyzed all the fundamental data of NIFTY 500 companies. After that, we have defined our quality index, ensuring that we will identify those companies with sound profitability, low debt structure and growth in their industry. From this index, we have chosen the first quantile as our portfolio. We will rebalance this portfolio annually concerning the benchmark (Quality 30), which is rebalanced semi-annually so that we can give enough time to companies to show price appreciation.

Statistics:

First, we will see if the NIFTY 200 Quality 30 outperforms the NIFTY 500 because we want to know whether itself is an excellent factor to consider while investing or not?

From the above graph, we can see that the Quality index has given 13.93 % CAGR since 2012, while NIFTY 500 has given 13.12 % CAGR and has a Sharpe ratio of 0.99 concerning the benchmark having a Sharpe ratio of 0.84. So now we understand that if the Quality index is performing better, let’s use our quality index and compare it with the benchmark.

Here we have named our strategy XC Quant: Quality and the benchmark is NIFTY 500. If we compare the results, it’s 32% CAGR from 2012, generating the alpha of 19.51% and has a Sharpe ratio of 1.69 compared to the benchmark, which has a Sharpe ratio of 0.85.

Let’s compare returns for all three, XC Quant: Quality, NIFTY 200 Quality 30 and NIFY 500.

From the above graph, we can see that XC Quant: Quality most of the time outperforms both indices.

The table below shows different quantile performances concerning the benchmark NIFTY 500 since 2012, which compares Sharpe ratio, returns, alpha, beta and risk.

It’s clear from the above table that the first quantile (XC Quant: Quality) outperforms in all the parameters of other quantiles and benchmarks. Look at the bar charts below, which compare the Alpha and Sharpe ratio.

Conclusion: The above study shows that the quality factor beats the benchmark. And we have also seen that the quality factor has subjectivity, so there can be many ideas and perspectives so we have created one portfolio, XC Quant: Quality. And this beats the benchmark in all the parameters.

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Xumit Capital

Xumit Capital is a boutique investment advisory firm that deals in equity, global & crypto portfolios and investment migration programs.