When building a quality portfolio, there are several key decisions on how to construct the strategy. For example: Should there be any constraints on sectors? How should companies be ranked against others?
Sector deviations are an element of risk that we can control, and we believe that it makes the most sense for sectors to be constrained. In other words, sector weightings should be similar to the broad market. This enables quality investors to gain exposure to the highest-quality earnings across all sectors, without making unintended bets on specific sectors.
Additionally, we believe it is prudent to compare quality characteristics of a company relative to its peers in the same sector. Sector comparisons allow companies to be scored on equal footing.
The MSCI USA Sector Neutral Quality Index applies a sector neutral weight to its parent index2 at each rebalance and also scores companies’ vs its peers. As highlighted in the chart below, the MSCI USA Sector Neutral Quality Index has very similar sector allocations to the S&P 500 Index, whereas the MSCI USA Quality Index has significant overweights to tech and healthcare, and underweights to energy, real estate, and utilities.