How Quality and Low Volatility Can Work Together in Portfolios

Exposure to the quality and low volatility factors can help portfolios remain defensive in the current environment.

With lots of uncertainty looming in the market, many investors want to maintain more defensive allocations. The quality and low volatility factors are both considered to be defensive factors. However, their individual qualities enable them to complement one another in portfolios.

“Despite being both defensive factors, you do see quite a bit of unique portfolio attributes between the two. You tend to see very low overlap between quality and low volatility: individual holdings, different kinds of sector makeups as well,” Chris Dahlin, factor & core equity strategist for ETFs and indexes strategies at Invesco, said on June 15 during “As Market Uncertainty Looms, Think Defensively.”

The two factors provide different exposure, giving them a somewhat different risk and return profile, Dahlin said.

Generally speaking, said Dahlin, the low volatility return profile tends to capture less downside, but also less upside. Low volatility also has a higher tracker error relative to the broader market than the quality factor.

Conversely, the quality factor tends to capture more upside than the low-volatility strategies. Therefore, quality tends to also capture more downside than the low volatility strategies — albeit still less downside than the broader market. Quality also tends to have less tracking error to the broader market than low volatility, Dahlin said.

There is a general lack of consensus on the exact definition of quality. However, Dahlin said generally the metrics for determining what a quality company looks like focuses on profitability, earnings quality, and financial robustness.

How to Access the Quality and Low Volatility Factors

Investors can access the low volatility factor through the Invesco S&P 500 Low Volatility ETF (SPLV), the Invesco S&P MidCap Low Volatility ETF (XMLV), the Invesco S&P SmallCap Low Volatility ETF (XSLV), the Invesco S&P International Developed Low Volatility ETF (IDLV), and the Invesco S&P Emerging Markets Low Volatility ETF (EELV).

The quality factor can be accessed with the Invesco S&P 500 Quality ETF (SPHQ), the Invesco, the S&P MidCap Quality ETF (XMHQ), the Invesco S&P SmallCap Quality ETF (XSHQ), and the Invesco S&P International Developed High Quality ETF (IDHQ).

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