The FlexShares US Quality Low Volatility Index Fund (QLV), which debuted last July, is new entrant to the low volatility ETF fray, but it’s off to a strong start and it could be in more upside in 2020 if investors continue embracing the low volatility and quality factors as they have in the past two years.
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 regional, sector and risk-factor constraints, in order to manage unintended style factor exposures, significant sector concentration, and high turnover.
“The performance leadership is similar to the last decade with the Low Volatility and Quality factors exhibiting the highest returns, albeit less extreme in magnitude than in previous years,” according to Factor Research. “Value continued to generate negative returns and the performance accumulates to what can be considered a lost decade for investors focused on buying cheap and selling expensive stocks.”
Asking A QLV Query
“Our research suggests that low volatility strategies have historically often resulted in portfolios with significant sector biases (e.g. utilities, consumer staples, etc.) that may result in unintended sector risks and potential interest rate sensitivity that investors may not have been expecting,” according to FlexShares.
Quality should not be conflated with low volatility, but there are times when quality stocks display low volatility traits. That was the case during the fourth quarter of last year’s market swoon, indicating that the quality factor can provide some protection during times of elevated market stress.
It’s also worth noting links between low volatility and value aren’t as intimate as some investors may be led to believe.
“There is no structural relationship between these two factors from a historical perspective, but in 2019 these behaved liked polar opposites, which was especially apparent from May onward, where Low Volatility generated strongly positive and Value significantly negative returns,” notes Factor Research.
QLV may present investors with a surprising opportunity: the ability to capture some momentum.
“Specifically, we observe that Momentum was highly correlated to the Low Volatility and Quality factors while being negatively correlated to Value,” notes Factor Research.
This article originally appeared on ETFTrends.com.