MSCI Quality Index
I was unaware MSCI had beaten AQR to the punch by producing a boatload of quality indices last spring. These are applied worldwide, so they are necessarily more parsimonious than AQRs...but jeez, these are really barebones:
1) Net Income/Book Equity
2) Debt/Book Equity
3) Earnings volatility over 5 years
Instructively, they Winsorize the data, which everyone should do to financial ratios (ie, truncate extremums). But, book equity in the denominator? Earnings volatility over 5 years? Those seem like bad choices, and AQR's quality index will be superior.
I have a feeling MSCI is a bit confused, as they have another tab noting their 'Risk Premia Indexing', which they note
The risk-begets-return model of economics is clearly nonfalsifiable amongst current financial academics and their coterie. They still say interesting things on occasion, so it doesn't render them useless, but it definitely impairs their ability to see and interpret reality.
1) Net Income/Book Equity
2) Debt/Book Equity
3) Earnings volatility over 5 years
Instructively, they Winsorize the data, which everyone should do to financial ratios (ie, truncate extremums). But, book equity in the denominator? Earnings volatility over 5 years? Those seem like bad choices, and AQR's quality index will be superior.
I have a feeling MSCI is a bit confused, as they have another tab noting their 'Risk Premia Indexing', which they note
An accumulating body of empirical research has found positive gross excess returns from exposure to factors (or risk premia) such as Value, Momentum, Low Size (small firms), and Low Volatility stocks. The studies show that these factors historically have improved return-to-risk ratios. Today, interest in risk premia (also known as smart beta or alternative beta) has been widespread across the institutional investor community.In other words, risk premia are really return premiums, because predictable returns only come from risk (in theory). But then, they also 'improve return-to-risk ratios', because, as we all know, these factors aren't risk in any obvious way, so strangely they all have 'excess return' premia. Indeed, 'value and size were initially thought to be due to distress risk, which would show up only episodically. Alas, 'quality' is basically an metric of anti-distress, and this generates a return premium, which MSCI occasionally calls a 'risk premium'...so basically whatever asset outperforms over the next 20 year period will ex post be declared risky.
The risk-begets-return model of economics is clearly nonfalsifiable amongst current financial academics and their coterie. They still say interesting things on occasion, so it doesn't render them useless, but it definitely impairs their ability to see and interpret reality.
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