Specifically, the quality factor is based on profitability, efficiency, earnings quality and limited leverage, which have historically been a good way to separate good companies from weaker ones. A volatility screen is also in place to focus on stocks that exhibit lower volatility, which tend to perform better. Additionally, the funds select stocks with strong dividend yields, which have also typically outperformed. The result is a portfolio of quality global companies and brands, O’Brien said.
O’Leary also advised investors to look beyond U.S. markets and include international exposure for a more diversified investment portfolio. International markets may zig as U.S. markets zag, bolstering returns or limiting pullbacks. For example, over 2015, U.S. equities returned 1.4% while European markets rose 10.3% and Japanese stocks gained 12.1%.
Investors can also gain exposure to Asia and Europe through the O’Shares FTSE Europe Quality Dividend ETF (NYSEArca: OEUR) and the O’Shares FTSE Asia Pacific Quality Dividend ETF (NYSEArca: OASI). OEUR tracks the FTSE Europe Qual / Vol / Yield Factor 5% Capped Index. OASI follows the FTSE Asia Pacific Qual / Vol / Yield Factor 5% Capped Index.
Zucker explained that the multi-factor FTSE Russell Indices are constructed by taking a stock’s market cap weighting multiplied by all factor scores – quality, volatility and yield – to generate an unadjusted weight. Those with the highest overall score would then be given a larger allocation within the Index.
Michael Venuto, Co-Founder and Chief Investment Officer of Toroso Investments, also pointed out that funds like OUSA have a clear process for security selection that allows investors to gain exposure to active management styles in a passive index-based ETF wrapper.
So far this year, this alternative, multi-factor indexing methodology has worked out for the smart-beta ETFs. For instance, OUSA’s underlying index’s overweight consumer goods and utilities components have helped the fund outperform the benchmark FTSE USA Index, which is overweight financials and technology segments.
Looking ahead, O’Shares will be aggressively expanding its ETF suite with 17 new fund strategies waiting on approval from the Securities and Exchange Commission. The new ETF filings all show a common “Quality” theme, which suggests that the underlying indices will also employ a type of smart-beta indexing methodology to weed out weaker securities.
Financial advisors who are interested in learning more about quality, smart-beta strategies can watch the webcast here on-demand.