Rethink your volatility toolkit - quality & min vol

• In periods of market uncertainty, investors may be tempted to sell out of equities and sit in cash; however, investors could consider maintaining their equity allocations by adding resilience to their portfolios with quality and min vol.
• Companies with quality characteristics tend to have higher profitability, lower leverage, and more consistent earnings. By considering leverage, investors may be able to avoid stocks that can be challenged in periods of distress.
• For more risk averse investors, using a minimum volatility ETF as a core holding, can help lower volatility in portfolios by seeking to reduce risk in equity allocations.

With the recent 25 basis point hike, the Federal Reserve has stayed committed to taming high inflation. The current banking crisis has raised concerns that the pace and magnitude of the hikes are leading to cracks in the economy.

In response to rising market uncertainty, investors may be tempted to reduce their equity exposure, seeking the relative safety of high-quality fixed income or cash. However, there are ways that investors can maintain their long-term equity allocations while adding resilience to their portfolios with quality and minimum volatility.

In anticipation of periods of economic slowdown, bond investors may move into higher quality companies, reasoning that they may hold up better in a market downturn. Equity investors can follow the lead of their fixed income counterparts, adding exposure to higher quality stocks in an attempt to add resilience to their portfolios.

A Robust Definition of Quality: The MSCI USA Sector Neutral Quality Index, the index that QUAL seeks to track, takes a multiple metric approach to defining quality that considers how profitable a company is, how much leverage they use, and how stable their earnings are over time:

• Focus on profitability: target firms with high return on equity, which may act as a cushion should the economy start to slow
• Avoid excessive leverage: leverage can be an effective tool to fuel growth, but excessive amounts can represent a burden if the economy slows
• Earnings consistency matters: a preference for firms with a history of consistent and predictable earnings in good or bad economic conditions

Thoughtful Portfolio Construction: Once higher quality companies have been identified, an investor can build a portfolio that provides strong exposure to the quality factor. The MSCI USA Sector Neutral Quality Index,¹ which is the index that QUAL seeks to track provides:

• Concentrated exposure: target the 30% of the market that scores highest across three quality metrics
• Sector neutral approach: avoid persistent bets that may result from targeting profitability (e.g., overweight technology) and leverage (e.g., underweight financials)
• Selective within industries: a focus on quality leads the fund to typically avoid bank stocks (within financials) and favor semiconductors (within technology)

The iShares MSCI USA Quality Factor ETF (QUAL) seeks to deliver deep exposure to high quality companies in a sector neutral framework, ideal for investors looking to add resilience to their equity portfolios while maintaining a return focus.

Investors seeking a more defensive exposure may consider a minimum volatility portfolio, which seeks to deliver equity exposure but with less volatility than the broad market.

Seeking risk-reduction at the core of your portfolio: We believe risk is more than volatility. The MSCI USA Minimum Volatility Index, the index USMV seeks to track, takes a holistic view when considering risk:

• A sophisticated risk lens: evaluate a stock’s risk based on exposures across a set of macro and style factors as well as stock-specific risk
• Manage risk at the portfolio level: consider both volatility and correlations to identify low-risk, and potentially diversifying, stocks
• Limit sector bets: 5% caps on active sector weights help the index manage other sources of risk and serve a role as a core position
• Core equity exposure with less volatility: The MSCI USA Minimum Volatility Index² has delivered roughly 17% less volatility on average than the S&P 500 index since inception

Investors seeking to maintain long-term equity allocations while managing volatility and downside risk may want to consider the iShares MSCI USA Minimum Volatility ETF (USMV) which seeks to deliver exposure to the US large and mid-cap equity market with significantly less volatility.

Equity investors face challenging market conditions from persistent inflation, high interest rate volatility, and the potential for a slowing economy. In periods of uncertainty, investors can look to the quality and minimum volatility factors to help add resiliency to their portfolios. Regardless of outlook, the iShares suite of factor ETFs provides a set of tools investors can use to navigate uncertain markets.