The quality factor is standing tall again in 2020 as investors lean on companies with strong balance sheets. A redux is expected in 2021 and investors can prepare for that scenario with exchange traded funds like the FlexShares US Quality Low Volatility Index Fund (NYSE: QLV).

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.

“Amid the tumult of 2020, safety-seeking investors have rewarded companies with strong balance sheets, but they also want growth,” reports Teresa Rivas for Barron’s. “Goldman Sachs says that means that companies willing to put their cash to work can continue to outperform in 2021.”

How QLV Chooses Quality Companies

QLV integrates rigorous fundamental analysis through a quality screen of US-based companies that 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 YTD Performance

“In contrast with history, many of the strongest balance sheet stocks are also the fastest-growing firms,” Goldman analyst Ryan Hammond wrote. “The basket has also dislocated from traditional measures of solvency risk such as credit spreads, suggesting that investors are seeking the cash flow flexibility and growth—rather than just the safety—of strong balance sheets.”

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.

Goldman’s “basket of 50 companies with strong balance sheets is up 26% year to date, making it the bank’s best-performing thematic strategy,” according to Barron’s. That underscores the benefits of the quality factor and the accessibility of QLV.

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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.