Factor-based mutual funds: Fit or flop? | Value Research Let’s understand what factor investing is and then do some data-crunching to decode their performance

Factor-based mutual funds: Fit or flop?

Let's understand what factor investing is and then do some data-crunching to decode their performance

Factor-based mutual funds: Fit or flop?

Mutual funds that follow factor investing have caught people's fancy in recent years. But have they really delivered?

For the uninitiated, factor investing looks at a wide range of factors to select a stock. Some of the most popular parameters of factor investing are:

  • Quality: This factor fundamentally looks at a company's stability of earnings, profit margins, cash flow and debt levels.
  • Value: This helps identify stocks that are trading at a discount as compared to the intrinsic value of the company.
  • Momentum: These are stocks that have done well in the last 6-12 months. Investors pick these stocks believing they will continue to rise.
  • Low volatility: Here, investors identify stocks that are least volatile.

Given the rising popularity of factor investing, several mutual funds have mushroomed in recent years that track momentum, value, growth and volatility-based indices.

So, let's look at how these styles have performed against their investment universe since their launch.

As you can see, most of these styles have not added much value, and the returns are pretty similar to their investment universe.

Value is the only exception because they have been red-hot in the last two years.

Quality, meanwhile, underperformed as compared to its investment universe of 200 stocks.

2022 performance
Last year was a test of faith for most of these investing styles, except for value, because they performed strongly in 2021 and 2022.

Quality and momentum were particularly affected, losing investors' money, while volatility barely managed to keep its head above water.

Individual fund performance
Two factor-based funds have gained high investor traction in particular.

One is UTI's momentum fund, and the other is ICICI's volatility fund.

Launched in March 2021, UTI's debut year was a smash hit, delivering returns of a little over 40 per cent, but 2022 was sobering as it ended with a negative 5.47 per cent return.

ICICI unrolled their low volatility ETF back in 2017. Until December 31, 2022, it has given 12.79 per cent returns versus the 13.08 per cent delivered by its investment universe of Nifty 100. The underperformance can be attributed to the low volatility style.

While factor-based funds have grown in popularity, they have not proven their ability to beat their investment universe in their short span of existence.

Suggested read: Buy-and-hold vs high turnover portfolio: Which large-cap fund is better?

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