In this episode of “ETF 360,” VettaFi’s head of research, Todd Rosenbluth, spoke with Michael Natale, senior vice president, head of intermediary distribution at Northern Trust Asset Management, to discuss the benefits of low volatility and quality strategies in today’s markets. FlexShares is managed by Northern Trust.
“Anecdotally, when the market becomes more volatile, we see a flight to quality and a flight to lower volatility names, and I suspect that many of us, if not everyone listening today, has experienced this themselves as well as on behalf of their clients,” Natale said.
Low volatility strategies tend to perform strongly during times of uncertainty: this means that during economic slowdowns or contractions, the low volatility factor outperforms, while in strong, recovering markets, the factor struggles.
“The low volatility factor outperforms over a full market cycle, and it’s because of this outperformance in slowdowns and contractionary periods,” explained Natale.
On the other hand, the quality factor offers outperformance across all parts of the macroeconomic cycle historically, in contractions and expansions; Natale compares them to all-weather tires, offering performance regardless of the conditions.
“Our research at Northern Trust shows that when we combine quality with low volatility, it smooths out factor cycles, allowing to not only enhance performance but also to reduce risk,” Natale said.
So what does this mean for advisors and investors? Combining the two factors in a singular strategy means that the quality factor can help mitigate some of the underperformance that can happen for low volatility during recoveries and expansion.
Natale discusses the correlations between quality and low volatility: high-quality and low-volume securities are generally not significantly correlated, whereas low-quality and high-volume securities tend to have a much higher correlation.
FlexShares offers a suite of quality and low volatility factor ETFs: the FlexShares US Quality Low Volatility Index Fund (QLV ) offers domestic U.S. exposure, the FlexShares Developed Markets ex-US Quality Low Volatility Index Fund (QLVD ) offers global developed country exposure, excluding the U.S., and the FlexShares Emerging Markets Quality Low Volatility Index Fund (QLVE ) which offers emerging market exposure.
“Here’s the most important part about the QLV suite at FlexShares: we want to put control mechanisms into these portfolios. We’re firm believers that you do not want to take on the risk that you’re not compensated for,” explained Natale.
FlexShares does this by putting limitations on individual security representation, country representation in QLVD and QLVE, and sector representation. It allows the funds to be sector neutral and, therefore, easy to incorporate into a portfolio as both a core allocation or a complement to existing allocations.
“Many advisors that we’re talking to feel that we’re on the cusp of a potential recession if we’re not already there, and if you believe that this is the case where we are and that we could see even more downward pressure, low volatility makes a lot of sense right now,” Natale stated.
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