Investing Intelligently Internationally

Benjamin Graham is the second most famous investor in the world, surpassed only by his pupil Warren Buffett. Such was his influence on Buffett, Buffett named his son, Howard Graham after his mentor. Benjamin Graham’s magnum opus is his book on value investing, ‘The Intelligent Investor’. In his preface to the fourth edition, Buffett calls the book, “the best book about investing ever written.”

The book details how investors can avoid the trappings of becoming speculators. Graham defines investors as those that seek the preservation of the principal of their investment and an adequate return. Investment decisions not having these objectives, Graham says are made by speculators and are exposed to higher risks and costs. Investors invest for the long term, through the market cycle.

According to the book the term long-term investor is redundant. There is only one kind of investor. “Someone who can’t hold their investment for more than a few months at a time is doomed to end up not as a victor but as a victim.”

The book is littered with examples of the shortfalls of attempting to time the market. Markets are unpredictable. The challenge for investors is to find and stick to an approach that captures growth beyond the average returns of markets. This is easier said than done. Graham suggests a number of ways for investors to go about this.

A recurring theme of ‘The Intelligent Investor’ is that investors should demand from a company “a sufficiently strong financial position and the prospect that its earnings will at least be maintained over the years.”

Graham defines a strong financial position as one in which long-term debt does not exceed current net assets and a high return on equity (ROE). Graham argues the best way to determine the prospect that earnings will be maintained is to examine the earnings of the company for the past ten years.

It would be impossible for “intelligent” Australian investors diversifying internationally to analyse these characteristics for each company around the world.

MSCI, one of the world’s largest index providers, does the work for us. MSCI analyses the stocks in its global universe and identifies the companies with the strongest fundamentals for inclusion in its ‘Quality’ Indices.

According to MSCI, “Quality growth companies tend to have high ROE, stable earnings that are uncorrelated with the broad business cycle, and strong balance sheets with low financial leverage.”

MSCI’s description matches the characteristics Graham insists investors should demand from companies and is the basis for the MSCI’s World ex Australia Quality Index.

MSCI only includes the highest scoring, top 30% by market capitalisation of its global universe. MSCI Quality scores are based on three fundamental factors:

1. ROE;
2. Earnings variability; and
3. Debt to equity ratio.

VanEck’s MSCI International Quality ETF (ASX code: QUAL) tracks the MSCI World ex Australia Quality Index which means “Intelligent Investors” can access a portfolio of 300 quality international companies in a single trade on the ASX.

Since its launch in 2014, QUAL has outperformed the returns of the market as measured by the MSCI World ex Australia Index.

Table 1 – QUAL Performance to 31 May 2023

*Inception date is 29 October 2014

Source: Morningstar Direct, VanEck.  The chart above shows past performance of QUAL and of the MSCI World ex Australia Index. You cannot invest directly in an index. Results are calculated to the last business day of the month and assume immediate reinvestment of distributions. QUAL results are net of management fees and other costs incurred in the fund, but before brokerage fees and bid/ask spreads incurred when investors buy/sell on the ASX. Returns for periods longer than one year are annualised. Past performance is not a reliable indicator of future performance. The MSCI World ex Australia Index (“MSCI World ex Aus”) is shown for comparison purposes as it is the widely recognised benchmark used to measure the performance of developed market large- and mid-cap companies, weighted by market capitalisation. QUAL’s index measures the performance of 300 companies selected from MSCI World ex Aus based on MSCI quality scores, weighted by market cap x quality score at rebalance. Consequently QUAL’s index has fewer companies and different country and industry allocations than MSCI World ex Aus.

Last year, VanEck recently launched a microsite to help investors understand the quality factors – click here.

The long-term results of Graham’s practices are well documented and evidenced by the ongoing success of his many high-profile pupils.

Given Graham’s most famous student famously told his own investors that they would be better off investing in low-cost index funds, we think for international equities, Graham would have invested in QUAL.

VanEck offers three ETFs that invest in quality companies that track MSCI Quality indices: The VanEck MSCI International Quality ETF (ASX: QUAL), an Australian dollar hedged version of QUAL which has ASX code: QHAL, and the VanEck MSCI International Small Companies Quality ETF (ASX: QSML).