The Science Behind Quality Bluechip – Quant smallcase
Introduction
We are stoked to present a new smallcase from the Windmill Capital suite – Quality Bluechips – Quant. This smallcase is a multi-factor strategy that optimizes on two main factors – Quality & Price Trend.
Let’s individually talk about both these factors –
- Quality
Quality has long been a core pillar of fundamental analysis, though its definition varies. To address this, we developed a proprietary Quality Score based on four financial metrics:
- Management Effectiveness is determined using Return on Equity (ROE)%
- Financial Strength is evaluated using the Debt/Equity ratio
- Earnings quality is estimated using an accrual ratio ((Net income – Free Operating Cash Flow) / Total Assets)
- Consistency in performance is gauged through earnings variability over the past 5 years.
Based on the quality score, companies can be assigned to any of the 4 quartiles.
Since it’s a relative score, companies in Quartile 1 (Q1) exhibit superior quality characteristics compared to those in Quartiles 2 (Q2), 3 (Q3), or 4 (Q4). This factor helps us identify and focus on fundamentally strong companies relative to the broader universe, effectively weeding out weaker options.
- Relative Price Trend
To gauge relative price strength, we calculate normal returns for each stock and divide this with the volatility of the stock in the same period. Essentially, we are gauging the following three aspects:
- Normal Returns, where we take into account the, to analyze the price strength of individual companies.
- Volatility, where we take into account the, to analyze the consistency of trend in each stock.
- Additionally, we also use certain metrics to analyze the sustainability of the aforementioned trends.
Using the price trend factor, we further filter companies that not only demonstrate superior quality but also exhibit stronger price performance relative to the universe in focus.
Methodology
Moving on to the methodology of the smallcase –
- Universe
Universe refers to a set of securities that are eligible for selection based on predefined criteria. It serves as the starting pool from which a portfolio is built. For Quality Bluechips – Quant smallcase the investment universe comprises the top 250 publicly traded companies on the National Stock Exchange, ranked by market capitalization. This universe is dynamically updated during the monthly rebalance period to reflect changes in market cap rankings.
- Rules
Rules, as the name suggests, govern stock selection, weighing mechanism, rebalance frequency, and other important facets of portfolio construction. Following are the rules that this smallcase follows –
- On Quality, picks companies that are fundamentally stronger as compared to the broader universe.
- On Price trend, pick companies who exhibit stronger and sustainable price strength as compared to the broader universe.
- We weed out companies who have shown irregular price strength in this period.
- Risk Management
We try to select 15 stocks in the smallcase during each rebalance period. However, if sufficient stocks do not meet the defined criteria, the portfolio tilts towards gold ETF to preserve capital until favorable conditions return.
- Rebalancing
The smallcase would have a monthly rebalance frequency.
Investor Suitability
The smallcase is curated in such a way that investors can take exposure to quality and promising companies in India who are experiencing positive momentum trends. This smallcase is suitable for investors who want to invest in a momentum based portfolio without the volatility associated with smallcap companies.
As far as its positioning is concerned, this smallcase can be a good addition to an investor’s satellite portfolio. Time and again, we have spoken about the core-satellite approach. In case you need a refresher, click here.
| Name | Investment Horizon | Fees |
|---|---|---|
| Quality Bluechips – Quant | Long Term | ₹3,000 per quarter |
Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of a SEBI recognized supervisory body (if any) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.
The content in these posts/articles is for informational and educational purposes only and should not be construed as professional financial advice and nor to be construed as an offer to buy /sell or the solicitation of an offer to buy/sell any security or financial products.Users must make their own investment decisions based on their specific investment objective and financial position and using such independent advisors as they believe necessary.Windmill Capital Team: Windmill Capital Private Limited is a SEBI registered research analyst (Regn. No. INH200007645) based in Bengaluru at No 51 Le Parc Richmonde, Richmond Road, Shanthala Nagar, Bangalore, Karnataka – 560025 creating Thematic & Quantamental curated stock/ETF portfolios. Data analysis is the heart and soul behind our portfolio construction & with 50+ offerings, we have something for everyone. CIN of the company is U74999KA2020PTC132398. For more information and disclosures, visit our disclosures page here.
