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Smart-Beta International ETFs With a Buffett-esque Approach


Investors can target quality international stocks through a new suite of so-called Quality Mix exchange traded funds that mirror strategies employed by Warren Buffett.

In June, State Street Global Advisors launched a suite of foreign equity ETFs that track MSCI Quality Mix indices, including the SPDR MSCI World Quality Mix ETF (QWLD) , SPDR MSCI EAFE Quality Mix ETF (QEFA) and SPDR MSCI Emerging Markets Quality Mix ETF (QEMM) , along with a handful of country-specific offerings. [New ETFs Help Cement MSCI’s Status as Indexing Leader]

The underlying MSCI indices are based on the principles taken from AQR researchers Andrea Frazzini, David Kabiller, and Lasse Pedersen’s paper “Buffett’s Alpha,” which argues that Buffett’s public equity portfolio can be explained by value, quality, and low-volatility factors, writes Morningstar analyst Samuel Lee.

“While I don’t believe they’ve completely distilled Buffett’s essence into a set of mechanical rules, they’ve captured enough of it,” Lee said.

The ETFs’ indices equally weights the MSCI’s value, quality and minimum volatility factors.

Specifically, the value-weighted index component is based on book, sales, earnings and cash earnings – factors that are included in the Research Affiliates Fundamental Index. The quality index ranks stocks based on high returns on equity, low five-year earnings variability and low debt-to-equity ratio. The minimum volatility index uses an optimizer with constraints to minimize portfolio volatility.

“The QM index is broadly diversified, owning stocks with opposing characteristics,” Lee said. “Value stocks tend to be dogs, while quality stocks are darlings, so mixing the two produces market-like portfolios that don’t seem to deviate much from the index.” [Qualifying Emerging Markets Quality]

The indexing methodology essentially cuts out less fundamentally sound stocks that typically outperform during bull markets but perform horribly during bearish conditions. Consequently, lower quality stocks usually don’t recover in a bull market.

“In back-tests the QM index tends to slightly lag during bull markets and greatly outperform during bear markets,” Lee added.

For more information on ETF strategies, visit our indexing category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.