Mutual fund unlocked: Factor based ETFs

The recent fall in the equity market has put some of the broader indices technically into a bear phase (falling more than 20 per cent). Besides, there are more than 500 stocks that have lost more than 20 per cent in the last one month alone. This may help index funds and exchange-traded funds (ETFs) get better attention from investors, as they have performed better in the same period.

Currently ETFs and index funds together corner around 8 per cent of equity asset under management (AUM) and 4 per cent of total domestic mutual fund AUM. Besides, the simple ETFs, which track an index such as Nifty and Sensex, there are some ETFs that are hybrid models and though track some index, they are deliberately biased in one or more respects. These are often referred to as 'factor ETFs'.

A factor is a characteristic or set of characteristics that both explains performance and provides an above market return. Some of the factors that have proved to be a better performer are value, momentum, quality, Beta and size. According to the data published by NSE, risk-adjusted returns from their multi-factor indices are much better than those from the benchmark Nifty 50. These multi-factor indices are also well-diversified with a mix of large and mid-cap stocks

In the Indian context, out of 64 passive equity funds in the domestic mutual fund market, 44 track the two major frontline indices that is Sensex and Nifty and rest single factor indices like Nifty Alpha 50 and multi-factor indices such as Nifty Alpha Low Volatility 30.

The last 1-year and 3-year returns of the factor-based indices have been better than the frontline and broader indices. For example, Nifty 50 in last one year ending August 31, has given a return of 19.4 per cent compared to 22.01 per cent by Nifty Alpha 50.

These funds are yet to get the desired attention from the investors, however, going ahead, once investors are more aware of these funds, we may find more acceptance for these factor-based ETFs.