Low volatility isn’t flashy, but it is still a beloved investment factor. How funds like the FlexShares US Quality Low Volatility Index Fund (NYSE: QLV) capture it in practice is important to investors.
QLV follows the Northern Trust US Quality Low Volatility Index. The ETF’s benchmark employs a quality screen to provide exposure to high-quality companies with lower absolute risk, thereby limiting potential future volatility. The quality screen analyzes a broad universe of equities based on key indicators such as profitability, management efficiency, and cash flow, and then excludes the bottom 20% of stocks with the lowest quality score. The index is then subject to the regional, sector, and risk-factor constraints, in order to manage unintended style factor exposures, significant sector concentration, and high turnover.
“In a higher volatility market environment, it’s important to keep in mind that downside and upside volatility don’t have an equal impact on returns,” according to FlexShares research. “For example, if a portfolio returns -20% in one month and rises 20% the following month, the result isn’t a breakeven. Rather, due to compounding returns, the portfolio nets a 4% loss. It’s for this reason that more investors are turning to low volatility strategies for downside risk mitigation in the face of rising volatility.”
QLV: Shooting for the Right Low Vol Structure
QLV integrates rigorous fundamental analysis through a quality screen of US-based companies that can be viewed as a means to mitigate future volatility. FlexShares believes this is different than other low volatility funds that may utilize only historical return and/or correlation data in hopes that the lower volatility will carry forward.
The ETF also offers a deeper approach to less volatility.
“We believe that a company’s financial health is important when constructing low volatility strategies. Metrics such as profitability and cash flow are key to assessing the quality of a company, and our research shows that the poorest quality companies also tended to be the most volatile. As such, incorporating the quality factor into volatility strategies to eliminate low quality companies can result in a more targeted low volatility experience,” notes FlexShares.
QLV has the potential to outshine standard low volatility strategies while providing investors with decent growth allocations and exposure to the value resurgence.
The fund is “designed to provide exposure to companies that possess lower overall absolute volatility characteristics, while also exhibiting financial strength and stability, or what we believe are quality characteristics,” adds FlexShares.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.