What is factor-based investing?

There are various ways in which you can have exposure to the stock market then may it be via mutual funds or direct investment in stocks or even by investing in ULIPs (Unit-Linked Insurance Plans). There are various strategies adopted and implemented by the fund manager in case of mutual funds and ULIPs and in case you are investing directly then you may have your own strategy.

What is factor-based investing?
Factor-based investing is nothing but a strategy wherein the stocks are picked based on its different attributes that may be associated with its risk and returns. There are two types of factors that drive returns and risk of stocks, bonds and other assets viz. macroeconomic factors and style factors. Investing based on macroeconomic factors include credit, inflation, liquidity, etc. whereas, style factors include value, momentum, quality, etc.

Some of the style factors

1. Value

Value is a factor which generally follows the value-based investing principle. Here stock’s price to book, price to earnings, dividend payout, etc.

2. Momentum
This factor is based on the assumption that the stocks that have outperformed in the past tend to provide good returns in the future.

3. Quality
This considers the attributes that show the quality of the stocks. The attributes considered are return on equity, debt to equity ratio, etc.

4. Volatility
This is typically termed as low volatility. This is a risk factor wherein it tries to understand which is the least volatile stocks and to combine it with returns factor to get better proposition this factor is always inverted.

Performance of Factor Index



If we look at the price movement of the factor indices and the Sensex, we can see that since launch i.e. from December 14, 2015 to June 26, 2019, momentum index is doing better than other indices. If we look closer then low volatility index behaves similar to the Sensex, this shows a strong positive correlation between low volatility index and Sensex. Enhanced value index initially performed well but then it started underperforming all the indices in the study. So, from a long-term point of view, other indices seem to be better than the enhanced value index. Quality index does perform in line with that of Sensex and at some point, it had also taken over the Sensex.