Faced with highly concentrated domestic indices, US investors should consider diversifying globally. Yet, international markets are often characterised by
lower-quality businesses, highlighting the need for a refined investment
approach. This blog explores the importance of quality in markets outside the
US and how Tema’s approach aims to identify high-quality international companies
that endure.
For a list of current fund holdings, please visit the fund web page at https://temaetfs.com/funds. All investments involve risks, including possible loss of principal. For a more complete discussion of the potential investment risks to the topics discussed below see the disclosure section at the end of the document.
Today, many investors are wary of the US market's concentration in "Magnificent 7" stocks. The relentless rise of these and other US equities has established one of the longest US versus international outperformance periods in history, akin to the Dotcom boom.
Source: International companies represented by MSCI World ex US Index, US companies by S&P 500 Index. 5 year monthly rolling returns 1975-2025 YTD
Yet regime shifts do occur, and international stocks have historically experienced extended outperformance cycles. There is some indication this trend is commencing in 2025, with US outperformance hitting a 12 year low when measured on 5-year total return.
The valuation case is also strong, especially in international quality stocks. Currently, these international quality firms trade at a significant 34% discount to equivalent firms in the US.
Source: MSCI
Investing abroad introduces distinct risks: currency fluctuations, varied regulatory regimes, cultural differences, and political instability. International companies, on average, exhibit lower quality than their US counterparts. While many outstanding firms operate globally, a significant number fail to generate sufficient returns on capital. Currently, over half of internationally listed companies report a return on assets below 6% i.e. well below cost of capital, compared with only a quarter in the US.
Source: International refers to Developed markets ex US, GMO
This argues that applying a quality lens to international markets could lead to a big improvement over a broad allocation.
International markets are also home to some of the world’s leading businesses. Often these are companies with no equivalent in the US, like luxury goods leaders Ferrari and Hermes. Even in technology, where the US is dominant, international markets are home to companies like TSMC, the world’s most sophisticated semiconductor manufacturer, or ASML, the commanding leader in lithography machines used to make chips.
Exposure to the quality factor generally enhances returns across markets, and this improvement is particularly pronounced in developed markets outside the US. Using Fama-French high and low quality large cap portfolios from 1990 to May 2025 shows that risk adjusted returns improve by 153%. This uplift nearly doubles that observed in US markets, underscoring quality's heightened importance in non-US international markets.
Source: Fama-French website. Quality represented by the operating profit factor crossed with large cap. Low quality is the BIG LoOP and high quality is the BIG HiOP portfolios in Developed Markets ex US. Data from 1990 to May 2025.
Note: Sharpe Ratio is a measure of risk-adjusted return that shows how much excess return an investment generates for each unit of risk (volatility) taken.
Traditional quality definitions often emphasize backward-looking financial metrics, such as returns, at the expense of durability. Yet, this is crucial in equity markets: for a firms' stock prices to appreciate, they must continually exceed expectations, a condition only ensured by durability. Many investors ignore this, focussing instead on growth and value. We believe to pick the best companies requires asking which will be alive and thriving 10 or even 20 years from now. Warren Buffet put it best when he said:
“Your goal as an investor should be simply to purchase, at a rational price, a part interest in an easily understood business whose earnings are virtually certain to be materially higher, five, ten, and twenty years from now.” [1]
Durable quality investing combines two core principles:
Firms with these qualities generate outsized returns on invested capital that, crucially, endure over very long periods. International markets offer numerous examples of such global leaders that are part of our durable quality universe.
Investing in international markets can be done directly by picking quality companies. This is difficult given the qualitative analysis required to identify such stocks and the individual equity risks involved in holding them. While investors could consider funds such as ETFs, that track broad international indices or those applying traditional quality metrics, these approaches can fall short by including firms lacking durable quality.
The Tema International Durable Quality ETF (ITOL) is an actively managed fund that seeks to invest in durable quality companies that possess tangible, dominant, and durable moats. The fund seeks to apply the durable quality approach as described above, and as already deployed for several years in the US via the Tema Durable Quality ETF (TOLL), to investing in firms listed outside of the United States. These international firms exhibit financial characteristics associated with quality, such as high recurring revenue, strong earnings visibility, and inflation-linked revenues, which collectively contribute to their potential for generating persistently higher returns on invested capital.
International companies offer US based investors diversification, especially against a technology dominated market. They are also more attractively valued and are less covered by Wall Street analysts.
International investing carries inherent risks, as average firm quality is often lower than in the US. Investors should look to adopt a quality lens, in order to identify global leaders and avoid poor-return companies, which can enhance risk-adjusted returns.
Tema’s quality approach focuses on durability, seeking firms that offer mission-critical products and services and possess tangible, dominant, durable moats. These firms generate high, enduring returns on invested capital, potentially leading to outperformance.
There are several risks investors should consider.
Regulation/Government interference – Government interference often targets dominant businesses through legislation or regulation. ITOL seeks to avoid companies that exploit customers, that tend to attract the most punitive intervention.
Valuation – Markets often assign higher multiples to quality companies, reducing the margin of error for investing. Tema addresses this by integrating valuation into its four security selection pillars, aiming to acquire companies at a discount to historical levels.
International investing should be a consideration for all investors looking to diversify. However, taking a quality lens is vital to avoid the predominance of lower quality companies in international markets. Tema’s International Durable Quality approach aims to do just that while focussing on companies with expanding barriers to entry, capable of generating sustainable returns on internal capital over very long periods.
[1] Berkshire Annual Report, 1996