Quality investing and the cross-section of country returns

The main purpose of this study is to examine the role of quality as a determinant of a cross-sectional variation in country-level stock returns. The study attempts to address the question: Is there any special premium for top-quality stock markets with decent profitability, indebtedness and liquidity ratios?

The computations are based on the listings of 66 country portfolios over the period between 2000 and 2013. Long/short country portfolios from sorts on characteristics related to quality are examined with asset-pricing models.

The inter-market variation in returns may be explained with profitability and debt ratios: the more profitable and the less indebted is the stock market, the better is its performance. Moreover, the performance of country-level value, size and momentum strategies may be improved by double sorting on quality characteristics.

The practical implications include such issues as the global asset allocation, the development of investment products, asset pricing and investment performance measurement. The country selection strategies that are based on leverage and profitability prove to be a useful tool for investors with a global investment mandate. Furthermore, additional sorting on quality metrics may markedly improve the performance of inter-market value, size and momentum strategies.

This paper examines the role of quality metrics related to financial leverage, profitability and liquidity in explaining the cross-sectional variation in country returns.