In the recent webcast, Factor Fundamentals for Your Portfolio, Michael Hunstad, Head of Quantitative Strategies, Northern Trust Asset Management; and Michael Natale, Head of Intermediary Distribution, Northern Trust Asset Management, outlined the various equity factors that can be used to adjust to different macroeconomic conditions.
For example, during a contraction, low volatility and quality factors have outperformed. In a recovery period, the size and value factors stand out. In an economic expansion, size and value continue to take charge, albeit at a lower pace. Lastly, in an economic slowdown, momentum usually shines.
Equity market factors can exhibit varying performances. In 2020, the momentum factor outperformed, while value and dividend yield factors underperformed by very wide margins.
However, conditions have quickly changed in 2021. In just the first quarter of this year, the markets have shifted from a growth to value. In the first quarter, value outperformed, followed by the size and dividend yield factors. On the other hand, the momentum, low volatility, and quality factors underperformed. The energy and financial sectors have been the leaders since the vaccine announcement. Despite the recent gains, value stocks remain at their cheapest level relative to growth since the dot-com era bubble.
To help investors better tackle the various market environments, FlexShares offers factor solutions tied to the four different economic cycles. For example, the FlexShares Morningstar U.S. Market Factor Tilt Index Fund (NYSEArca: TILT) tries to provides enhanced exposure to U.S. equities by tilting the portfolio toward the long-term growth potential of small cap and value stocks. For international exposure, investors can look to the FlexShares Morningstar Developed Markets Ex-US Factor Tilt Index Fund (NYSEArca: TLTD) and the FlexShares Morningstar Emerging Markets Factor Tilt Index Fund (NYSEArca: TLTE). These size and value factor ETFs can be great for a market in the recovery phase.
The FlexShares US Quality Large Cap Index Fund (CBOE: QLC) selects and weights companies based on management efficiency, profitability, and cash flow to determine quality. Management efficiency is a quantitative evaluation of a firm’s deployment of capital and its financing decisions. Profitability scores help weed out firms with wider margins, which may be better positioned to grow. Lastly, cash flow signals the liquidity level of a company. Those with higher cash flows may be better situated to take advantage of potential opportunities or enjoy a financial cushion in downturns. QLC’s exposure to size, value, and momentum factors can be a good way to play an expansion phase.
Investors seeking stability, along with exposure to the growing U.S. markets, can look to the FlexShares Quality Dividend Index Fund (NYSEArca: QDF), FlexShares Quality Dividend Dynamic Index Fund (NYSEArca: QDYN), FlexShares Quality Dividend Defensive Index Fund (NYSEArca: QDEF), FlexShares International Quality Dividend Index Fund (NYSEArca: IQDF), FlexShares International Quality Dividend Defensive Index Fund (NYSEArca: IQDE), and FlexShares International Quality Dividend Dynamic Index Fund (NYSEArca: IQDY). The suite includes a group of smart beta ETFs that focus on both quality and dividends, which are favorable factors during a slowdown phase.
Lastly, investors may turn to quality and low volatility strategies to hedge risks during a contraction phase through ETFs such as the FlexShares US Quality Low Volatility Index Fund (NYSE: QLV), FlexShares Developed Markets ex-US Quality Low Volatility Index Fund (NYSE: QLVD), and FlexShares Emerging Markets Quality Low Volatility Index Fund (NYSE: QLVE).
Financial advisors who are interested in learning more about factor investments can watch the webcast here on demand.