Investors are increasingly turning to factor funds for their ability to deliver higher returns and better risk management, offering a smart alternative to traditional mutual funds.
To achieve greater returns and better risk control, investors are shifting to factor funds that have emerged as superior alternatives to mutual funds. These funds work on a particular approach where they invest based on values such as value, momentum, quality, and low volatility.
This means that instead of grouping funds in specific categories or regions, the market factor approach of a factor fund gives portfolio construction a well-defined and logical structure. The increase in the numbers can be attributed to the fact that they can diversify portfolios and risks, hence providing more stable returns over the medium to long term. The UTI Nifty 500 Value 50 Index Fund gave as high as 66% in one year while the Motilal Oswal BSE Enhanced Value Index Fund gave 65%. The objects of even lower rates of factor funds have been producing the results at between 32 percent to 37 percent levels which are substantially higher than traditional market indices.
Market Forces and Stability in Factor Investing
Of all the factors, the most important is momentum. It chooses the stocks that are showing high returns to other similar stocks, thereby capturing up movements in the market. Although, momentum is a two-edged tool in that it is sensitive to market direction. To mitigate this risk, almost all factor funds use both price momentum and other factors, such as quality or low volatility, which usually move in opposite directions. This combination offers a more stabilized return that would significantly dampen during bear phases.
One of Mr. Sarkar’s fellow co-founders of the Wealth Redefine – an AMFI (Association of Mutual Funds in India) registered mutual fund distributor, noted that since these funds are based on identified trends in the fund market, these funds can outcompete traditional mutual funds by exploiting these trends and other inefficiencies. “And as it has been seen in the long run, the factor funds that are more tailored to produce better returns.”
What Are Factor Funds?
Factor-based funds are a form of actively managed funds. They purposely “tilt” portfolios toward certain stock characteristics, like recent momentum, higher quality, or lower stock prices to achieve specific risk and return objectives. But they come with significantly more risk than you’d experience investing in the broader stock market. Factor-based funds select investments based on specific characteristics or “factors” that can affect a stock’s performance
Factor Funds: Which One to Choose?
The choice of a factor fund should be made in line with the investor’s objectives and risk appetite. If an investor needs stability, low beta or quality-oriented funds are ideal to invest in. These funds tend to invest in businesses with regular profits and little fluctuations for more conservative investors in their 40s or with investment periods of 3-5 years at most. On the other hand, value seekers may opt for momentum or small-cap mutual funds as they are high-growth positive stock funds with high risk. It could take about five to seven years to see the benefits resulting from these strategies.
As Nirav Karkera, Head of Research at Fisdom, noted, “Momentum can be a carrier of high returns, but the downside is it is prone to large losses during bearish markets.”
Smart Money for Life: The Role of Factor Funds
There are multiple pitfalls to factor investing, yet the long-term wealth generation opportunity is vast. Both value and momentum strategies exhibit cyclicality, which may result in poor performance at some stages, though their continuous contribution significantly boosts portfolio returns. “Concerning the factor premiums and the compounded returns, the performance can be boosted over longer durations,” says Anil Rego of Right Horizons.
According to analysts, it is important to diversify across factors with excellent results in the long run. Periodic updates and holdings rebalancing are required to make sure that the fund corresponds to the investor’s strategy. According to the founder of Wright Research, Sonam Srivastava, “They are not immune to the ups and downs of the market, but some of them, like low volatility, do act as a buffer to losses during the turmoil.”
What should investors look for in factor-based funds?
Investors should look for funds that are data-driven, evidence-based, and offer controlled risk management. However, market volatility can impact factor-based funds differently depending on the factors they target – which indeed should be studied to ensure a positive outlook.
Investments are subject to market risks. This document should not be treated as endorsement of the views/opinions or as investment advice. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital.
