Last Updated on November 2, 2023 at 8:40 am
A few years ago, when the NSE introduced factor indices, aka smart-beta investing, I was among the first to get excited and wrote a slew of articles such as these: (1) Are Nifty Smart Beta (strategic) Indices better than the Nifty Next 50? (2) Picking Stocks With Low Volatility: A simple but effective strategy? (3) Nifty High Beta 50: an unsmart beta strategy
Factor investing combines the benefits of active stock picking based on a pre-defined definition and passive investing. A factor-based passive fund is more expensive than a market capitalization-based passive fund but less expensive than a traditional active fund. Index curators push factor indices as a”market-beating” option on an absolute or risk-adjusted basis, as it aids their revenue if more AMCs launch products that track such indices.
My enthusiasm was short-lived when an industry expert I admire pointed out that the definitions and stock baskets are cherry-picked to produce good results with past data. This does not mean they will work in future. He summarised his thoughts here: Data Mining in Index Construction: Why Investors need to be cautious.
He later pointed out something that I did not realise: There is a significant phase lag between ideas that turn into products in the “West” and in India. When the Indian MF industry and the Indian investor turned their attention to factor indices, the West had already started recognising that these funds would not always outperform. See, for example, Factor ETFs Fail to Deliver Their Promised Outsize Returns. More and much older articles can be found searching for “factor investing failure”.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! 🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
Soon after the Nifty Midcap150 Quality 50 index was launched, I analyzed its performance and found Midcap mutual funds struggle to beat it. Soon, the index was added as a benchmark to our monthly equity mutual fund outperformance screener.
Thanks to his counsel (he does not wish to be named), I was significantly mellowed in my appraisal of the UTI Nifty Midcap 150 Quality 50 Index Fund and DSP Nifty Midcap 150 Quality 50 Index Fund. The crux of the argument is that the definition of “quality” (and “value”) is quite arbitrary.
I continue to believe in “low volatility”. I am invested in UTI S&P SE Low Volatility Index Fund and use the notion for my occasional stock picking: Stock Portfolio Analysis: Oct 2023 (which, by the way, is not doing so well in the last few months, but my intention with it is to serve as an income source so I am not too worried). Our anti-factor expert does not think much about low volatility either. 🙂 Guess I will live and learn some lessons here!
This is the performance of Nifty Midcap150 Quality 50 vs Nifty Midcap150 since inception.
If you casually look at this, this seems like a “wow” graph advertising the efficacy of the quality factor. A closer look would tell you that the factor index has had at least two drawdowns (fall from a peak) higher than the base mid cap index – during the 2020 crash and the fall since Oct 2021. Still (some would argue), “quality” has outperformed. Not so fast.
This is the performance over the last 12 years. To the left of the arrow is a 10-year window where the factor index has done well. To the right of the arrow is the last two-year window.
The ten-year outperformance from Oct 2011 to Oct 2021 has been erased by poor performance over the last two years. And how bad have the last two years been?!
As someone commented on social media, “Looks like someone fell asleep at the wheel”! The quality factor fell more than the broad market mid cap index and did not recover as much over the six months, as shown below.
I am unaware of the reasons behind this poor performance, and I am not interested in finding out as we would only end up with opinions. Also, this does not mean the quality index will always underperform in future.
These results mean only one thing: Factor indices can underperform for significant periods and erase past gains. If you consider higher fees compared to broad-market passive funds, the underperformance will be higher.
Those who “believe” in factor indices must be ready to go through such rough patches. Most investors are not capable of this. Therefore, we recommend sticking to a simple Nifty or Sensex index fund.
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our YouTube Videos
- Posts feed via Feedburner.
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.Your Ultimate Guide to Travel
This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)