Investor Corner/The asset classes/Factor Investing and ESG
2.6.4 Quality & Low-Volatility Factors
The quality factor favours companies with high return on equity, low debt and stable earnings. The low-volatility factor favours stocks that swing less than the broader market. Both have tended to provide better risk-adjusted returns over full market cycles.
What quality actually screens for
A quality-focused strategy looks for companies with financially sound characteristics, strong and stable profitability, conservative use of debt, and consistent earnings rather than erratic, unpredictable ones. The underlying idea is that financially sturdier companies tend to navigate difficult economic periods more successfully than weaker, more leveraged competitors.
What low volatility actually screens for
A low-volatility strategy selects stocks that have historically shown smaller price swings than the broader market, aiming to capture a smoother overall ride. Somewhat counterintuitively, low-volatility stocks as a group have, over some long historical periods, delivered returns roughly comparable to or even better than the broader market, despite carrying meaningfully less risk along the way.
Why both tend to shine during downturns
Both quality and low-volatility strategies have historically tended to hold up relatively better than the broader market during sharp downturns, since financially sturdier, steadier businesses generally suffer proportionally less during periods of genuine economic stress than more speculative or highly leveraged ones.
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