The Rise of Factor Investing | ET Money

[Music] every four decades the world of investing experiences a significant shift in the 1930s it was value investing which brought in a data-driven information-led approach to valuing companies in the 1970s passive investing via index funds and etfs gained popularity and in the last decade or so we are seeing the emergence of factor investing which marries active and passive investing in one potent package now globally financial products linked to factor investing manage over 1.2 trillion dollars in assets which is clearly a big number and while this number is far ahead of what we have in india the last 12 to 18 months have seen the introduction of a number of factor-based schemes in the etf and index fund variants in fact fund houses have lined up seven new offerings this month which includes the value momentum quality and low volatility factors about which we'll study in greater details in the coming section of this video with that being said let's begin [Music] the value factor is probably the most documented and definitely the most studied of all factors in the investment industry simply put the factor is based on the idea that companies with lower valuations tend to generate a higher return and vice versa to put a number to this our research shows that growth companies are defined as those 30 of stocks which have the highest book value to market cap ratio and likewise value stocks are the lowest 30 of stocks when sorted by that same ratio so while the book value to market cap ratio is one way of defining value the snp bse value index uses a different methodology which comes together as a combination of metrics surrounding the book value price earnings and sales in fact the value factor within the indian mutual fund space has two types of schemes firstly there is the nifty 50 value 20 fund which is offered by ics prudential kotak and nippon india and then there is the newly introduced motilal oswal bse enhanced value fund the nifty 50 value 20 index as the name suggests seeks to filter out 20 stocks from within the nifty 50 list of companies this is done by assigning weights and then ranking companies on the basis of their return on capital employed their p ratio their price to book ratio and their dividend yield as one can imagine a high roc and dividend yield and a low pe and pb ratio fetches a higher score on this value seeking scoreboard now since the icsa prudential kotak and nippon india nifty 50 value 20 fund all rely on the same nsc stock selection methodology all three funds come with the same constituents weightages performance and risk grading when compared to the nifty 50 index we find that the value 20 index has handsomely outperformed the broader index over these last five years and has done that at a lower level of fertility in fact when we expanded the performance data over many years we found that generally the value 20 index returns are somewhat around the nifty 50 barring the beer markets of 2013 2018 and 2020 when the value index did exceedingly well to put it differently the value factor does relatively better in beer markets so that's something investors might want to watch out for [Music] the momentum factor is a bit odd at least on a conceptual level and that's because this factor conceptually says that stocks that have performed well in the past as compared to the peers will continue to perform well in the short run and vice versa in other words let the winners keep winning and allow the losers to keep losing so essentially momentum investing is a bit like a high turnover trading strategy that requires a constant moving into and moving out of stocks to capture the upside now while more details on momentum investing are available in another video on a youtube channel in this video i'd like to give you a quick snapshot of the nifty 200 momentum 30 index which is now available with multiple fund houses including uti idfc alitabila so as the name suggests this nifty 200 momentum 30 index filters out 30 stocks from the nifty 200 list of companies based on a predetermined methodology which manages the selection normalization and the waiting criteria and while the index itself was launched just a year back its back-tested results show that momentum investing has had a strong run for many years with some cracks only visible during the beer markets of the year 2000 2008 a little bit in 2018 and of course in the first half of 2020. so if you use history as a guide here the momentum investing strategy seems to be working extremely well when the markets are rising but not too well when the beer market sets in [Music] unlike other factors like momentum and value there is a lack of consensus on what quality exactly means now generally a company's quality emanates from it being highly profitable having a strong balance sheet with low financial leverage and the same queues are used by the s p quality index which applies three sub factors to measure a company's quality number one it uses the company's return on equity and understandably higher the rov the better it is secondly the factor uses the balance sheet accruals ratio which is defined as the change in a company's net operating assets over the last year divided by its average net operating assets over the past two years of course the lower this accrual ratio is the better it is because a higher ratio might mean that the company did not receive cash for the sales that they've already made and finally there is the financial leverage ratio which is calculated as the company's total debt divided by its book value in fact the motilal oswal snp bse quality index fund ascribes to the above definition of quality while other schemes like the nifty mid cap 150 quality 50 schemes by dsp and uti or the nifty 200 quality 30 schemes by sbi and alkabila sun life and edelweiss mutual funds nifty 100 quality 30 fund tend to follow slightly different approaches for comparison's sake we have used the nifty 200 quality 30 index and the table here shows that the quality factors performance tends to go up and down across years in the moderate band of six to eight percent so there's not a lot we could observe here in isolation but for your decision making benefit we'll try to put all of this together when we arrive at the summary of this video and with this let's move on to the last of our four factors which is low volatility [Music] conventional wisdom suggests that by taking a higher risk one is likely to receive a higher return and while that might work in most cases what's also true is that there are many studies that show how equity assets with a lower risk quotient tend to outperform the higher response it's an approach that gained popularity after the 2008 global financial crisis as more investors sought defensive less volatile stocks which meant that a low volatility strategy performed well in bearish or range-bound markets as one can imagine the idea here is to pick the least volatile stocks and volatility here is generally calculated as the standard deviation of daily price returns for the last one year or so this very approach is used in the nifty 100 low volatility 30 fund managed by icsa prudential and kotak while the uti and motilal oswal schemes utilize the snp methodology in their corresponding offering so as expected the low volatility factor does have a much lower standard deviation as compared to the market cap factor nifty 50. but if returns are the primary consideration for you then a comparison with the broader indices shows that the low volatility factor does not offer a whole lot of alpha in fact in most years the low wall 30 index has just about matched the nifty 50 and nifty 200 which makes us question the utility of this factor although many funds have been mixing the low volatility factor with other factors like alpha to get a better bank for the buck [Music] at its most basic level factor-based investing is simply about defining and applying a set of rules and while we have discussed four primary factors here the global analyst fraternity uses a combination of over 300 different factors with the singular objective of delivering benchmark meeting returns to its investors within the indian mutual fund space we are seeing more fund houses adopting factor-based investing with one of the newer fund houses nj asset management even positioning itself as a dedicated factor based asset manager but to keep things simple and decision worthy let's put down a couple of important lessons that you can take home with you firstly we have to recognize that the winners keep on changing i mean look at this colorful table here notice how every factor has had a decent chance to feature within the top two ranks although the momentum factor seems to have won most of it by staying within the top three except for the year 2022 the second point one should consider is the timing aspect you see in the bull phase of the market it's the momentum strategy that does extremely well and has beaten the nifty 200 tri by a margin of over eight percent in fact the momentum factor has had an alpha of over ten percent on all the other three factors making it the big bull of the rising markets however in a beer market it's the quality and low volatility factors that do a much better job of arresting the declines beating the momentum market cap and value factors by at least 10 percentage points so essentially if you as an investor can dynamically allocate to these factors in line with the market cycles then a lot more alpha can be generated over the benchmark and i'm not talking small numbers here because this can be a good 8 to 12 percent over and above what the nifty 50 or the nifty 200 offers so that's some food for thought and some homework for you but all said and done we believe the time for factor investing has arrived in india and we are likely to see a lot more action on this front as always the et money channel will keep you posted with the developments on this front and for more such updates do explore subscribing to our channel once again thank you for your time and i look forward to catching up with you on another insightful video until then mutual fund investments are subject to market risks read all scheme related documents carefully you

Channel: ET Money

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Keywords: factor investing, smart beta investing, factor investing explained, what is factor investing, multi-factor investing, stock market news, factor based investing, smart beta, five factor investing, factor investing etf, factor investing list, smart beta portfolio, smart beta funds, nifty, nasdaq, nifty tomorrow, nifty alpha, nifty live trading, nifty prediction, nifty 50 tomorrow prediction

Id: 76PgfgdOsjo

Length: 11min 59sec (719 seconds)

Published: Tue Aug 30 2022