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Quality Minus Junk

Last Updated on 10 February, 2024 by Rejaul Karim

Quality Minus Junk” is a research paper by Clifford S. Asness, Andrea Frazzini, and Lasse Heje Pedersen that investigates the definition, valuation, and returns of quality securities. The authors define a quality security as one exhibiting characteristics that should warrant a premium, such as safety, profitability, growth, and effective management.

Surprisingly, high-quality stocks tend to exhibit only modestly higher prices on average. This discrepancy may explain the anomalously high risk-adjusted returns observed for high-quality stocks. The study introduces a quality-minus-junk (QMJ) factor, which simultaneously goes long on high-quality stocks and shorts low-quality stocks, generating significant risk-adjusted returns across the U.S. and 24 international markets.

The paper also reveals the fluctuating price of quality over time and highlights how a low price of quality can predict high future QMJ returns. Finally, the study examines analysts’ price targets, exposing the low required return of quality stocks despite their high realized returns.

Abstract Of Paper

We define a quality security as one that has characteristics that, all-else-equal, an investor should be willing to pay a higher price for: stocks that are safe, profitable, growing, and well managed. High-quality stocks do have higher prices on average, but not by a very large margin. Perhaps because of this puzzlingly modest impact of quality on price, high-quality stocks have high risk-adjusted returns. Indeed, a quality-minus-junk (QMJ) factor that goes long high-quality stocks and shorts low-quality stocks earns significant risk-adjusted returns in the U.S. and globally across 24 countries. The price of quality varies over time, reaching a low during the internet bubble, and a low price of quality predicts a high future return of QMJ. Analysts’ price targets suggest that the required return of quality stock is low despite the high realized return.

Original paper – Download PDF

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Author

Clifford S. Asness
AQR Capital Management, LLC

Andrea Frazzini
AQR Capital Management, LLC

Lasse Heje Pedersen
AQR Capital Management, LLC; Copenhagen Business School – Department of Finance; New York University (NYU); Centre for Economic Policy Research (CEPR)

Conclusion

In conclusion, the comprehensive research paper “Quality Minus Junk” by Clifford S. Asness, Andrea Frazzini, and Lasse Heje Pedersen delves into the intriguing aspects of quality securities, defined by attributes such as safety, profitability, growth, and effective management.

The study highlights the perplexing observation that high-quality stocks display only marginally higher prices, a phenomenon possibly responsible for their high risk-adjusted returns. By introducing the quality-minus-junk (QMJ) factor, the researchers demonstrate how going long on high-quality stocks and shorting low-quality ones can result in significant risk-adjusted returns in the U.S. and across 24 international markets.

The paper also explores the fluctuating price of quality over time and offers the key insight that a low price of quality can predict high future QMJ returns. Additionally, the analysis of analysts’ price targets underscores the seemingly low required return for quality stocks, contrasting with their high historical returns.

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FAQ

Q1: What is the focus of the research paper “Quality Minus Junk,” and how do the authors define a quality security?

The research paper investigates the definition, valuation, and returns of quality securities. The authors define a quality security as one exhibiting characteristics that investors should be willing to pay a higher price for, including safety, profitability, growth, and effective management.

Q2: How does the paper explain the seemingly modest impact of quality on stock prices and the observed high risk-adjusted returns for high-quality stocks?

Despite high-quality stocks displaying only modestly higher prices on average, the paper suggests that this phenomenon may explain the anomalously high risk-adjusted returns observed for high-quality stocks. The authors introduce a quality-minus-junk (QMJ) factor, which involves going long on high-quality stocks and shorting low-quality stocks, generating significant risk-adjusted returns in the U.S. and 24 international markets.

Q3: What insights does the research offer regarding the fluctuating price of quality over time, and how does it connect a low price of quality to future QMJ returns?

The paper reveals the fluctuating price of quality over time, noting a low during the internet bubble. Importantly, it highlights that a low price of quality can predict high future returns of the quality-minus-junk (QMJ) factor. This insight provides valuable information for understanding and predicting market dynamics.

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