Impressively so, riskier assets recouped March losses and then some, but with uncertainty still a consideration, investors may want to consider a quality approach to equities via the FlexShares US Quality Low Volatility Index Fund (NYSE: QLV). Count Goldman Sachs among those endorsing quality for the remainder of 2020.
“The near-term uncertainties around the US outlook and the risk of longer-term economic consequences should continue to favor stocks with strong secular growth prospects and ‘quality’ characteristics,” according to the bank.
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.
Quality has historically outperformed other investment factors during economic slowdowns, but that thesis could be challenged if quality ETFs amass large positions in cyclical sectors, such as tech.
“Information Technology has the longest equity duration – our proxy for long-term growth prospects – and strongest balance sheets across all sectors,” notes Goldman. “While stretched in absolute terms, valuations for the sector appear justified by fundamentals and are still much lower compared with those during the Tech Bubble.”
Historical data confirm that the quality factor wins over the long-term as the most profitable companies have easily outpaced their less profitable peers by significant margins over longer holding periods. QLV’s benefits are on display this year.
Valuing high quality value is particularly important as bull markets enter their waning stages, as some market observers believe the current bull market is doing. In the early stages of bull markets, lower quality companies see their shares soar. However, as the bull matures, investors often exhibit a preference for higher quality fare with more compelling valuations.
“Material stocks have weaker balance sheets than the broader market, Goldman noted. Meanwhile, the bank believes pandemic-induced headwinds and stretched valuations will hamper the real estate sector,” reports CNBC.
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