Investing in low volatility stocks is often used as a defensive strategy by investors who want to participate in some of the market’s growth while potentially reducing their downside risk.
However, research by FlexShares finds that traditional low volatility strategies may introduce unintended sector concentration and interest rate risk, among other challenges.
Screening stocks for quality, as well as their relative volatility, may help address those problems and create a defensive strategy that offers greater upside capture and less downside risk, FlexShares states.
According to FlexShares, research conducted on stocks in the Russell 1000 Index between 1998 and 2016 found that the lowest quality stocks tended to experience higher levels of volatility, suggesting that incorporating a quality screen in a low volatility strategy may help further reduce volatility and add incremental returns.
The FlexShares US Quality Low Volatility Index Fund (QLV) is designed to provide exposure to U.S.-based companies that possess lower overall absolute volatility and that also exhibit financial strength, stability and, quality characteristics.
QLV, which is part of the firm’s stable of factor ETFs, seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Northern Trust Quality Low Volatility Index.
The index methodology first assesses financial strength and stability based on quality metrics like profitability, management efficiency and cash flow. The lowest-scoring companies are excluded.
Top holdings in QLV currently include Microsoft Corporation, Apple Inc., Johnson & Johnson, Eli Lilly and Company, and Home Depot, according to ETF Database.
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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