When the market starts to whipsaw, investors historically have sought out low volatility strategies, allowing them to potentially protect against some downside while staying invested in the market. Yet we believe this time-tested factor strategy can become even more powerful when combined with a screen for quality.
In the upcoming webcast, When Rates Rise, it’s Time to Combine Low Volatility & Quality, Jordan Dekhayser, head of the Quantitative Strategist Team at Northern Trust Asset Management, will take a deep dive into how to potentially protect against chaotic markets with quality, low-vol exposure in their core allocations.
As we face increased unknowns and a potentially volatile market response, investors may turn to quality and low-volatility ETF strategies to hedge risks and still maintain upside potential, such as the FlexShares US Quality Low Volatility Index Fund (QLV), the FlexShares Developed Markets ex-US Quality Low Volatility Index Fund (QLVD) and the FlexShares Emerging Markets Quality Low Volatility Index Fund (QLVE).
The three ETFs utilize 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 regional, sector, and risk-factor constraints, to manage unintended style factor exposures, significant sector concentration, and high turnover.
Additionally, quality should not be conflated with low volatility, but there are times when quality stocks display low volatility traits. The quality factor seeks to further reduce volatility and potentially add incremental returns, according to FlexShares. The quality and low volatility factors can also mitigate unintended sector biases and interest rate risks.
“Low volatility investing is an attempt to minimize the fluctuation of the value of an investment over a period of time and is often considered as a defensive strategy. Applying the quality factor to a low volatility strategy may allow an investor to capture more of the market upside potential while protecting against downside risks. The Northern Trust Quality Low Volatility Index historically has offered an upmarket capture ratio of 84% on average, while providing a down market capture ratio of 71% on average in comparison to the broad market index,” according to FlexShares.
Financial advisors who are interested in learning more about the the low-volatility and quality strategy can register for the Wednesday, July 20 webcast here.