Investors that are increasingly betting on a US recovery in the midst of a turbulent global economic scenario possibly should focus on large-cap US companies as part of their core holding. While there are nearly 120 exchange-traded funds that focuses on large-cap US equities through a variety of strategies including fundamentals, size, value, growth, sector, size, earnings, dividend yields etc, a fund that targets multiple factors were missing from the mix.
FlexShares, the ETF issuing arm of Northern Trust, recently launched a large-cap focused multi-factor smart-beta fund to fill the void. The FlexShares US Quality Large Cap Index Fund (QLC) seeks exposure in US large caps that exhibit distinguishable quality, value and momentum characteristics. The quality factor has always been under the lens of long-term investors and thanks to exchange-traded funds, they have also become most accessible off-late.
Quality of stocks is generally measured by a firm’s ability to maintain and raise dividend payouts though it must be mentioned that application of quality factors is still pretty much evolving among investors. FlexShares applies three criteria to measure quality: cash flow, profitability and management efficiency.
Cash flows indicate the level of liquidity for a business and businesses with strong free cash flows are in a better position to exploit potential investment opportunities while enjoying a better financial cushion during downturns.
Profitability, on the other hand, weeds out firms with lower margins and brings the focus back on companies that are better positioned to grow. Lastly, management efficiency is a quantitative metric that measures a firm’s deployment of capital and evaluates financing decisions.
QLC seeks to track the performance of the Northern Trust US Quality Large Cap Index, a float-adjusted market-cap based index that selects the largest 600 companies from the wider universe of the Northern Trust 1250 Index.
The fund imposes a range of restrictions to control risks including sector/ industry exposure constraints as well as beta and turnover constraints. QLC also employs various valuation techniques including Shiller’s CAPE or cyclically adjusted P/E and analysts’ forecasts for earnings.
Additionally, the fund attempts to avoid value traps by considering momentum attributes, which are determined from recent performance and price history, along with consensus estimates of analysts.
While QLC is well diversified with 118 stocks in its portfolio, you should note that US multinationals derive a substantial portion of their revenue and profits from sales outside of the US. Hence, many constituents of the S&P 500 may post weak results amid a faltering global recovery.
QLC has a gross expense ratio of 0.33 percent.
Disclosure: No holdingsContact Ulli