Check Out This ETF for Minimized Volatility With Upside Potential | ETF Trends

Investors favor low-volatility funds when they want to reduce their downside risk but still participate in some of the market’s growth.

Traditional low-volatility strategies may introduce unintended sector concentration and interest rate risk, among other challenges, but this may be mitigated by applying the quality factor to a low-volatility strategy, thus allowing an investor to capture more market upside potential while protecting against downside risks.

According to FlexShares, research conducted on stocks in the Russell 1000 Index between 1998 and 2016 shows that the lowest quality stocks tended to experience higher levels of volatility, suggesting that incorporating a quality screen in a low-volatility strategy further helps diversify the portfolio and reduce volatility without sacrificing returns.

The Northern Trust Quality Low Volatility Index has historically offered an upmarket capture ratio of 84% on average, while providing an average downmarket capture ratio of 71% in comparison to the broad market index, according to FlexShares.

Investors can gain exposure to the index with the FlexShares US Quality Low Volatility Index Fund (QLV), which is designed as a core equity allocation with strong market upside potential while reducing downside risk, according to FlexShares. The fund offers exposure to U.S.-based companies that possess lower overall absolute volatility and that also exhibit financial strength, stability, and quality characteristics.

The underlying index of QLV employs constraints on portfolio construction in an effort to produce a portfolio with potentially less sector bias which can also mitigate interest rate sensitivity compared to other low-volatility strategies.

Top holdings in QLV currently include Microsoft Corporation, Apple Inc., Johnson & Johnson, Eli Lilly and Company, and Home Depot, according to VettaFi. 

With a 22 basis point expense ratio, QLV charges just half of what its factor strategy segment peers charge — 44 basis points, on average. 

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