Quality versus Low Volatility ETFs

As different as night and day

April 2024. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Quality and low volatility stocks provide substantially different exposures
  • Neither has outperformed the stock market, but both were less volatile
  • Low volatility stocks have done poorly in recent years

INTRODUCTION

If you believe that the economy is entering a recession and can only invest in equities, what stocks should you select?

Well, first we should probably acknowledge that we are terrible at predicting recessions, and even measuring them in hindsight, so whatever strategy we come up with to select stocks bears a significant risk of backfiring.

However, ignoring this unpleasant fact, then most investors would likely go for quality or low volatility stocks when having a negative economic outlook. Given the COVID-19 crisis in 2020 and the bear market in 2022, it is a good time to reflect on how well either strategy has performed.

In this research article, we will compare quality versus low volatility ETFs.

FACTOR EXPOSURE ANALYSIS

We focus on quality and low volatility ETFs trading in the U.S. stock market, where iShares dominates both categories with their products, namely iShares MSCI USA Quality Factor ETF (QUAL) and iShares MSCI USA Min Vol Factor ETF (USMV), which have captured more than 70% of the assets under management.

In addition to these two funds, we include SPHQ, JQUA, FQAL, VFQY, and PSET as additional quality and SPLV, FDLO, ONEV, FLLV, LVOL, and SPMV as further low volatility ETFs. The fees range between 0.10% and 0.29% per annum, and quality ETFs are cheaper than low volatility ETFs with an average management fee of 0.17% versus 0.23%.

First, we run a factor exposure analysis using five equity factors and a one-year lookback, which highlights that the two strategies are quite different. The factor betas for the size and low volatility factors are positive for both strategies, but diverge for other factors. Most interesting is that low volatility ETFs have a negative beta to the quality factor (try Finominal’s Alpha Analyzer tool).