When looking at individual stocks and sectors, the quality factor holds a much greater tilt toward technology or information technology names, which have been outperforming – IT stocks generated 22% earnings growth in the most recent earnings season, compared to the 15% for the broader Russell 1000.
“Quality stocks exhibit lower leverage and considerably higher profitability than stocks with lower historical volatility. This further illustrates why investors may have favored quality at the expense of low volatility as the characteristics of high quality differ markedly from low-volatility stocks,” the OppenheimerFunds strategists said.
However, market conditions are dynamic and the one factor may fall out of favor in quickly changing environments. Consequently, OppenheimerFunds argued that investors should not focus solely on a single factor and instead consider a multi-factor approach to better diversify against all eventualities.
“Rather than counting on a single factor to buffer portfolios, adopting a multi-factor approach may be prudent in that it offers diversification during the times when defensive factors behave atypically. Further, a multi-factor approach that adjusts exposures based on current macro trends could help by tilting toward more cyclical factors should market sentiment accelerate or by remaining in more defensive factors should deceleration continue. Because high-quality and low-volatility stocks currently exhibit low correlations to each other, maintaining exposure to both may ultimately prove more effective than relying on only one factor,” according to OppenheimerFunds.
For example, investors can look to something like Oppenheimer Russell 1000 Dynamic Multifactor ETF (Cboe: OMFL) and Oppenheimer Russell 2000 Dynamic Multifactor ETF (Cboe: OMFS), which select companies through exposure to a subset of the low volatility, momentum, quality, size and value factors. Investors may combine the various factors to gain an easy-to-use and quick way to access a diversified market position. This combined factor or multi-factor, smart beta approach may be a good core position for any equity portfolio.
For more information on alternative index-based strategies, visit our smart beta category.