What is Factor Based Investing in India

Just like a blockbuster movie needs the right mix of story, stars, and action to succeed, a stock’s performance often depends on certain key traits called "factors." Factor-based investing is an innovative, data-driven strategy that uses these traits to pick better-performing stocks. It’s becoming increasingly popular with Indian investors.

Here’s the proof. The total assets managed by factor-based funds in India grew from ₹6,863 crore in December 2022 to ₹37,749 crore by December 2024.

Breaking Down the Factors

Factor investing involves targeting specific, measurable traits that have historically led to higher returns or lower risk. Let's examine two popular factors with real performance data from Indian funds.

1. The Value Factor

This strategy focuses on buying stocks that appear undervalued compared to their fundamentals (like earnings or book value). The value factor has recently delivered powerful returns.

• UTI Nifty 500 Value 50: 45.43% (1-year return)
• Motilal Oswal BSE Enhanced Value: 42.91% (1-year return)
• Nippon India Nifty 50 Value 20: 30.21% (1-year return)
  (Source: Value Research, as of Nov 29, 2024)

2. The Quality Factor

This factor prioritises companies with strong financial health, such as low debt, stable earnings, and high profitability. These are often durable businesses that can better withstand economic turbulence.

• Motilal Oswal BSE Quality Index Fund: 33.39% (1-year return)
• DSP Nifty Midcap 150 Quality 50 Index Fund: 27.19% (1-year return)
• UTI Nifty Midcap 150 Quality 50 Index Fund: 27.13% (1-year return)
  (Source: Value Research, as of Nov 29, 2024)

3. The Momentum Factor

This strategy focuses on buying stocks that have recently performed well. Momentum investing selects stocks with strong price gains over the past 3 to 12 months, based on the idea that stocks that have gone up in price are likely to continue rising in the short term. While this approach can generate high returns during strong market phases, it is also highly volatile and vulnerable to sudden losses when market trends shift.

4. The Low Volatility Factor

Also called "Minimum Volatility," this factor picks stocks that usually move less than the overall market. The aim is to get steady returns with lower risk. These funds aim to gain during good times while minimising losses during market falls.

For example, the Nifty100 Low Volatility 30 Index held up better than more aggressive strategies during a recent market dip.

Single-Factor vs. Multi-Factor Funds

Investors can access these strategies through two main types of funds:

• Single-Factor Funds: These funds, like the examples above, concentrate on one specific factor. They are ideal for investors who want to make a targeted bet on a characteristic they believe will outperform. The main risk is cyclicality; a single factor can underperform for long stretches if market conditions are not in its favour.
• Multi-Factor Funds: These funds use a mix of two or more factors in one portfolio. The idea is to reduce fluctuations, as different factors perform well at various times. For example, a fund might combine Value, Quality, and Momentum to balance risk and returns. 

A Hybrid Approach

So, how should you think about factor investing? It’s like a middle ground between the two main ways people invest:

1. Active Funds: A professionally managed portfolio in which the fund manager and research team use quantitative and qualitative analysis (e.g., company fundamentals, macroeconomic trends, valuation models) to select securities with the aim of outperforming a chosen benchmark index.
2. Index Funds: A passively managed portfolio that seeks to replicate the performance of a specific market index (for example, the Nifty 50) by holding the same securities in the same weights as that index. They aim to match, not beat, the index’s returns.

Factor investing takes the best parts of both.

• It's like an Index Fund because it follows clear, simple rules. There are no emotional decisions. A stock either fits the rule (like being a "Quality" company) or it doesn't.
• It's like an Active Fund because you are choosing not just to copy the market. You aim to achieve better results by focusing on proven factors.

This mix gives you a big advantage: a chance for better returns without the high fees.

Let's look at the yearly fees (called expense ratios):

• Active Funds: Are the most expensive. You could pay 0.5% to over 2%.
• Factor Funds: Are in the middle, usually costing 0.20% to 0.50%.
• Index Funds: Are the cheapest, often costing 0.05% to 0.30%.

Benefits of Factor Investing

Why is this strategy becoming so popular? The advantages are clear and supported by market data.

• Potential for Enhanced Returns: As per fund performance data, targeting specific factors like Value and Quality has historically given the potential for returns that can vastly outperform the broader market.
• Diversification and Risk Management: This is where factor investing truly shines. Different factors behave differently in various market cycles. A multi-factor approach can provide a crucial buffer during downturns.
  A real-world stress test: In a challenging market period between September 23, 2024, and March 15, 2025, the Nifty200 Momentum 30 Index fell by -31.25%. In contrast, the Nifty100 Low Volatility 30 Index saw a much smaller decline of -17.52%.
  This data clearly shows how a defensive factor (Low Volatility) can protect a portfolio from the steepest losses when an aggressive factor (Momentum) falters. By combining factors, investors can build a more resilient portfolio designed to navigate market turbulence more effectively.

Final Thoughts

Factor-based investing offers a transparent and structured path for Indian investors to build more robust portfolios. By understanding how different factors work and leveraging the power of diversification, you can move beyond traditional market-cap investing. However, it is vital to remember that no strategy guarantees returns, and a disciplined, long-term perspective is the key to success.

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