Investors looking to drill down on the quality factor can do so with an array of exchange traded funds, including the FlexShares US Quality Large Cap Index Fund (NasdaqGM: QLC).
QLC selects and weights companies based on management efficiency, profitability and cash flow to determine quality, according to FlexShares. Management efficiency is a quantitative evaluation of a firm’s deployment of capital and its financing decision. Profitability scores help weed out firms with wider margins, which may be better positioned to grow. Lastly, cash flow signals the liquidity level of a company, so those with higher cash flows may be better situated to take advantage of potential opportunities or enjoy a financial cushion in down turns.
“The quality factor originally was designed as a tool to gain confidence in the financial strength of dividend-paying equities, but investors have steadily evolved how they use it in their portfolios,” said FlexShares. “Instead of looking at dividend-paying equities as a means to meet income needs, quality dividend payers can also be looked at as a means to grow assets through their core investments.”
Why is Now the Time For Quality?
Valuing high quality value is particularly important as bull markets enter their waning stages, as some market observers believe the current bull market is doing. In the early stages of bull markets, lower quality companies see their shares soar. However, as the bull matures, investors often exhibit a preference for higher quality fare with more compelling valuations. To that point, nearly half of QLC’s holdings are considered value stocks.
“The extensive depth and history of financial data for these companies makes research quite robust, which in turn boosts convictions about how different factors perform in various market cycles,” said FlexShares. “And, liquidity and capacity issues, which may affect small caps or certain foreign markets, are generally not a concern.”
QLC skirts value traps by including momentum characteristics, which will be determined through a stock’s price history to capture a picture of the recent performance and by using analysts analyst outlooks to get a sense of future sentiment regarding a company. While QLC emphasizes quality, it actually is a multi-factor fund, a strategy that can prove useful for investors looking for the benefits of other factors beyond quality.
“The Large Cap Quality measurement process creates an alpha score based on the three targeted factors, which maximizes the strategy’s exposure to quality, value and momentum. The strategy strives to harness each factor through its selection and weighting process,” according to FlexShares.
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