Amid ongoing market volatility, investors tend to choose mutual funds which are less vulnerable to market correction, or the ones which are constituted with a particular set of considerations so that they can weather the financial storm without getting drawn into turbulence.
This form of investing is known as factor investing. It is, in fact, an investment approach that includes focussing particular drivers of return such as lower volatility or high value. There are a number of factors to build and enhance portfolios.
Factor investing is seen similar to passive investing, such as being low cost. It also has some of the characteristics of active management as it aims to generate returns above the index. The factor-investing is at nascent stage in India with only a dozen products with a small track record.
“Factor investing is quite popular in developed markets, as this encourages disciplined investments, removes emotional biases and takes advantage of chosen factors, i.e., low valuations/ high growth/ low volatility etc. Factor based investing in passive funds may be a good idea especially for investing in Large and Large – Mid cap equities, where it is tougher to create stock selection-based alpha and market corrections provide a index/market level opportunity,” said Abhishek Dev, Co-Founder and CEO of Epsilon Money.
Rajiv Shastri, Director and CEO of NJ AMC says that factor investing is still at a nascent stage in India.
"Since factor investing is still at a nascent stage in India and has a long way to go, investing in passive funds that merely replicate a factor index may not be the most advisable course to follow. Factor funds are rules-based active funds that undertake continuous efforts to improve the efficacy of the factors they are based on, and they do not replicate any external index," said Shastri.
Types of factor investing:
Value investing: It works on an assumption that stocks with lower valuations often generate higher expected returns in comparison to companies that have higher valuations. Some of the passively-managed mutual funds that use ‘value’ factor are Nippon India Nifty 50 Value 20 Index Fund, Kotak NV 20 ETF, ICICI Prudential NV20 ETF. These schemes have a track records of one to six years.
Momentum factor: It refers to the propensity of winning stocks to maintain the momentum and continue performing well in the near term. There are essentially three passively-managed momentum-based mutual fund schemes — Motilal Oswal Nifty 200 Momentum 30 ETF, UTI Nifty200 Momentum 30 Index Fund and Motilal Oswal Nifty 200 Momentum 30 Index Fund.
Low volatility factor: Much against the widely-held perception, some experts believe that lower-risk assets outperform their higher-risk counterparts over time. This is known as low volatility factor. It became popular after the 2008 Global Financial Crisis.
In India, there are six low volatility factor-based passive funds such as Motilal Oswal S&P BSE Low Volatility Index Fund, Kotak Nifty 100 Low Vol 30 ETF, Motilal Oswal S&P BSE Low Volatility ETF.
However, Ankur Kapur, Founder of Plutus Capital, says volatility has a positive side too. When stock rises sharply in a short period of time, it stems from its volatility only. Consequently, risk in a fund should be seen as something that can cause a loss of capital and not merely volatility, he implies.
“Interestingly, finance literature defines volatility using standard deviation, which means the extent of portfolio movement in comparison with the average. So, if your portfolio has grown from ₹1 lakh to ₹10 lakhs, as per finance literature, the portfolio is quite volatile, but this is a positive side of the volatility. Therefore, when an investor evaluates equity investment, risk should be seen as a probability of loss of capital and not volatility. The choice of the fund should be based on the soundness of the underlying portfolio, rather than choosing a fund with low volatility,” says Ankur Kapur.
