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Quality control

Equity investors endured a bumpy ride in 2018, and looking ahead most pundits expect the elevated volatility to continue in the near term. After all, looming trade tensions, rising interest rates, and the possibility of multi-regional economic slowdowns continue to create headwinds. For global investors there are added hurdles as well. In fact, global equity investing is viewed by many as challenging, confusing and perhaps even downright intimidating.

We remain undeterred. As global investors who pursue opportunities across 196 countries in eight distinct global regions, we fully acknowledge the potential currency, cultural and sovereign policy obstacles posed by investing across borders. Yet we believe that the diversification and growth potential far outweigh any added risks. Adhering to strong risk protocols that stress quality-oriented companies at a reasonable valuation gives us the confidence to navigate any added obstacles we face as global investors. 

But what, exactly, is “quality?” It can be a nebulous concept that holds different meaning for different investors. For us, it’s a simple belief that quality companies are those that should outperform over time thanks to three key attributes:

1) Deploy capital at a high and sustainable rate of return 
2) Generate strong and predictable cash flow
3) Demonstrate stable earnings growth, especially in a market downturn

So while some investors remain dubious of making a global allocation and others prefer a passive approach to the global equities universe, we believe that focusing on the above three quality attributes is a viable means to identify companies that may create shareholder value consistently. We think that stock selection based on these fundamentals will generate higher returns predictability over time. Consequently, we focus much of our efforts in understanding how businesses of these companies could perform under various market scenarios. 

But don’t just take my word for it. Consider what the historical data shows for the MSCI ACWI Quality Index.*  Of the 15 years in which the MSCI has tracked its quality factor data, quality companies have outperformed broader MSCI ACWI Index in ten of those years. Perhaps even more telling are the four down years – 2008, 2011, 2015 and 2018 –  where the MSCI ACWI Quality Index has outperformed its broader parent index. 

Thus, we think it’s hard to argue against using some sort of quality screen as a key ingredient to building a portfolio of global stocks. To find such companies, we score and rank every stock in our universe on many metrics, including those that assess company financials for their track records of efficient capital allocation, gross and net income profitability, earnings volatility and cash flow return on invested capital, among other items. Only then do we proceed to validate that these quality companies have sustainable, not transitory, prospects.  

Looking across the global landscape, we see thousands of great companies to choose from without the hindrance of borders. The key is to have a solid stock selection methodology supported by a robust underlying risk management framework to help navigate the challenges. Any market volatility and economic dislocations in different regions and at different times simply present viable opportunities for active management. Moreover, we believe that making correct top down allocation calls or specific “country calls” can be immensely challenging and require unbalanced and unnecessary risk-taking. Therefore, we do not forecast sector and regional performance. In our view, stock selection—and specifically quality stock selection—can be far more impactful to overall fund performance than macro allocation.

 

*The index aims to capture the performance of quality growth stocks within the broader MSCI ACWI Index by identifying stocks with high quality scores based on three main fundamental variables: high return on equity (ROE), stable year-over-year earnings growth, and low financial leverage. The MSCI ACWI Index is a leading global equity benchmark that includes large-and mid-cap stocks across 23 Developed Market and 24 Emerging Markets countries.

Diversification neither assures a profit nor eliminates the risk of experiencing investment losses. 

International investing involves special risks, which include changes in currency rates, foreign taxation and differences in auditing standards and securities regulations, political uncertainty, and greater volatility. 

Victory Capital, Inc. is a Registered Investment Advisor. The information in this article is based on data obtained from recognized services and sources and is believed to be reliable. Any opinions, projections or recommendations in this report are subject to change without notice and are not intended as individual investment advice. Not to be used as legal or tax advice.

©2018 Victory Capital Management Inc.

Consider the investment objectives, risks, charges and expenses of the funds carefully before investing. Download a prospectus or summary prospectus, if available, containing this and other important information for USAA mutual funds from www.usaa.com/prospectus, for Victory mutual funds from www.victoryfunds.com, or for VictoryShares and VictoryShares USAA ETFs from www.victorysharesliterature.com. Read it carefully before investing.

Investments involve risk including possible loss of principal. The value of the equity securities in which the fund invest may decline in response to developments affecting individual companies and/or general economic conditions. Dividends are never guaranteed. International investing involves special risks, which include changes in currency rates, foreign taxation and differences in auditing standards and securities regulations, political uncertainty, and greater volatility. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. You may lose money by investing. There are no guarantees the funds will achieve their investment objectives and strategies may be unsuccessful.

Investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk such as nonpayment of principal or interest, and risks of bankruptcy and insolvency. Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

ETFs have the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited and often commissions are charged on each trade, and ETFs may trade at a premium or discount to their net asset value. There can be no assurance that an active trading market for shares of an ETFs will develop or be maintained. The ETFs are not actively managed and may be affected by a general decline in market segments related to the Indexes. The ETFs invest in securities included in, the Index, regardless of their investment merits. The performance of the ETFs may diverge from that of the Indexes. 

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

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This material does not constitute a distribution, offer, invitation, recommendation, or solicitation to sell or buy any securities; it does not constitute investment advice and should not be relied upon as such.  Investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

Victory Capital means Victory Capital Management Inc., the investment manager of the USAA Mutual Funds and VictoryShares USAA ETFs. Victory Mutual Funds and USAA Mutual Funds are distributed by Victory Capital Advisers, Inc. (VCA). VictoryShares ETFs and VictoryShares USAA ETFs are distributed by Foreside Fund Services, LLC (Foreside). VCA and Foreside are members of FINRA and SIPC. Victory Capital Management Inc. (VCM) is the investment adviser to the Victory Mutual Funds, USAA Mutual Funds, VictoryShares ETFs, and VictoryShares USAA ETFs. VCA and VCM are not affiliated with Foreside. USAA is not affiliated with Foreside, VCM, or VCA. USAA and the USAA logos are registered trademarks and the USAA Mutual Funds and USAA Investments logos are trademarks of United Services Automobile Association and are being used by Victory Capital and its affiliates under license.

Nasdaq is a registered trademark of Nasdaq, Inc. and its affiliates (together,“Nasdaq”) and is licensed for use by Victory Capital. The product(s) are not issued, endorsed, sold, or promoted by Nasdaq. Nasdaq makes no warranties as to the legality or suitability of, and bears no liability for, the product(s). Nasdaq is not affiliated with a fund or advisor.

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