Investors Should Make Volatility Their Friend in Today’s Market

The coronavirus sell-offs in March was a crude reminder to investors that volatility is not to be forgotten even when times the good times are rolling, such as during an extended bull run. As witnessed in March, good times never last and that’s when investors should make volatility their friend.

Of course, that’s easier said than done—an investor with a low-risk aversion profile would easily disagree with the notion of befriending volatility.

“The problem is when markets are volatile, lots of different assets, good and bad, fall in price sharply, and that scares investors,” said Dan Kemp, chief investment officer at Morningstar in FT Adviser article. “But actually, it is from that volatility that opportunities arise. Without volatility, prices wouldn’t fall, and there would be [better] investment opportunities. Investors who try to time the market or are short-term in outlook don’t get the benefit of volatility, and instead, experience loss of capital.”

For those who can’t stomach the volatility, it’s important for investors to smoothen the ride with ETFs like the FlexShares US Quality Low Volatility Index Fund (NYSEArca: QLV). Rather than assume additional hedging positions to mute volatility, QLV has a low volatility component built into the fund.

Per the site’s fund description, QLV integrates rigorous fundamental analysis through a quality screen of US-based companies which can be viewed as a potential 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 the lower volatility will carry forward.

QLV Chart

QLV data by YCharts

Quality Scoring Model

The core components of the quality scoring model are based on the quantitative ranking of various metrics obtained from company filings. These scores consist of three core components: management expertise, profitability, and cash flow.

Additionally, QLV incorporates strict sector controls to help prevent the index from deviating too significantly from the broader US-equity market. Constructs the final constituents list with consideration to the exposure of the low volatility factor, we believe giving investors a more efficient means of accessing this factor.

QLV seeks investment results that correspond generally to the price and yield performance of the Northern Trust Quality Low Volatility Index. The underlying index is designed to reflect the performance of a selection of companies that, in aggregate, possess lower overall absolute volatility characteristics relative to the Northern Trust 1250 Index, a float-adjusted market capitalization weighted index of U.S. domiciled large- and mid-capitalization companies.

Fund facts:

  • Invests in US-based companies and employs quality factor as a tool to potentially mitigate future volatility
  • Utilize constraints to help optimize and remove biases
  • Maximize exposure to low volatility factor

For more market trends, visit ETF Trends.