Factor investing, also referred to as smart beta investing or rule-based investing, has been gaining steady momentum in the past few years.
Basically, the factor always aims to generate returns on the stock. This means that in factor investing, the target is on securities with special characteristics that decide the direction of returns.
In the equity market, there are various indices based on these characteristics, which include value, quality, momentum, size and low volatility, to list a few.
Here’s a look at a few of the types of factors that have been gaining in popularity, these include:
Value: In long-term investments, cheaper stocks with strong fundamentals have the potential to outperform. An example is NSE’s Nifty 500 Value 50 Index.
Momentum: Stocks that have performed well in the recent past will have the potential to do well in the future as well. On the other hand, stocks that have underperformed will tend to perform poorly in the future, too. An example is NSE’s Nifty 200 Momentum 30 Index.
Low volatility: The stocks chosen under this factor are those that have experienced modest stock price fluctuations. An example is NSE’s Nifty 100 Low-Volatility 30 Index, which tracks the performance of 30 least volatile stocks in the Nifty 100 Index. It aims to generate risk-adjusted returns based on lower-volatility stocks.
Quality: Quality-oriented, profitable companies tend to outperform the market. An example is the Nifty 200 Quality 30 Index.
Factor investing strategy is active and passive. However, it is neither as passive as buying traditional index nor as active as taking a view on individual stocks. A point to be noted is that it may not be necessary that only one factor has been used in the factor-based fund, there are a few funds that follow multi-factor indices, too.
In order to gauge the returns in factor investing, factor indices are compared with their respective universe. For instance, Nifty 50 Equal Weight and Nifty 50 Value’s universe would be Nifty 50.
Ideally, the focus should be on year-to-date (YTD) or one-year returns, as most factor indices have existed for one or two years. In 2023, most factor indices have outperformed their universe.
When it comes to factor investing, investors’ portfolios are likely to be constructed based on a single factor or a combination of multiple factors; these are mostly dependent on investment objective, risk appetite and investment horizon.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.