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Low Vol & Quality: Two Popular ETF Factor Flavors

This article was originally published on ETFTrends.com.

Among factor-based strategies, low or minimum volatility and quality are again proving popular with advisors and investors in 2019. The iShares Edge MSCI USA Quality Factor ETF (Cboe: QUAL) and the iShares MSCI USA Minimum Volatility ETF (Cboe: USMV) are among the exchange traded funds (ETFs) benefiting from that theme.

QUAL seeks to track the investment results of the MSCI USA Sector Neutral Quality Index composed of U.S. large- and mid-capitalization stocks exhibiting quality characteristics as identified through racks U.S. large- and mid-capitalization stocks based on quality screens for three fundamental variables: return on equity, earnings variability and debt-to-equity.

The low-volatility factor investments work on the idea that they help cushion against market turns, limiting drawdowns that investors experience while providing upside potential. Consequently, the low- or min-vol strategies may produce better risk-adjusted returns over the long haul, which has been backed by extensive academic research.

“Investors have frequently turned to Quality and Minimum Volatility strategies for just this type of resilience.,” said BlackRock in a recent note. “We have seen evidence of this trend in flows into iShares Edge MSCI USA Quality Factor ETF (QUAL) and iShares Edge MSCI Min Vol USA ETF (USMV). Year to date through February 28, 2019, flows into QUAL and USMV totaled $1.8B and $2.6B respectively. These flows followed combined inflows into the two funds of $7.2B in 2018.”

Exploring The Factor Funds

USMV is up more than 13% this year and resides near all-time highs. USMV’s underlying index “seeks to create a holistic portfolio with lower risk than the market, without taking large individual stock or sector bets. This focus has historically facilitated more stable returns over time providing resilience when market returns are more erratic, or are suffering severe downside losses,” according to BlackRock.

Both quality and low volatility have histories of outperforming traditional broad market strategies when stocks decline.

“In down markets, the Quality factor and the Minimum Volatility factor have outperformed the broader market 71% and 79% of the time, respectively,” said BlackRock.

The quality factor is a point of emphasis for a growing number of strategic beta exchange traded funds. Though there has been debate surrounding defining quality as it pertains to factor-based investing, quality companies and dividend-paying stocks often go hand-in-hand because those dividends are seen as signs of stable earnings and thoughtful management.

“Quality strategies seek enhanced returns versus the market through exposure to profitable companies with less debt and more stable earnings. Since the Quality factor has historically delivered more upside capture with less downside resilience, it may be more appropriate for risk-aware, return seeking investors,” according to BlackRock.

For more information on alternative index-based strategies, visit our Smart Beta Channel.

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