Factor-based funds are catching on in India. Are they right for you?

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Subscribe to enjoy similar stories. Passive investing has rapidly gained traction in India, with assets under management (AUM) of ₹11 trillion, or 16.5% of the ₹68 trillion mutual fund market. This space is dominated by exchange traded funds (ETFs) and index funds designed to mirror the returns of underlying indices.

However, a growing number of investors are now shifting to factor-based funds, also known as factor funds or smart beta strategies, which aim to outperform the benchmark. They currently account for 2% of total ETF and index fund investments, with AUM exceeding ₹27,000 crore. One of the key advantages of factor funds is that they blend the benefits of both active and passive investing.

They offer the potential for higher returns like actively managed funds, but at a relatively low cost, like passive funds. Factor funds select for specific factors such as momentum, value, volatility, quality and value. Research has shown that these factors have historically influenced investment returns, forming the basis of most popular factor funds.

Let’s decode some prominent types of factor funds. Momentum factor funds track momentum indices, which include stocks showing strong upward price trends on the expectation that these trends will continue. Price movement is the core criteria for selecting these stocks.

Globally, this is the second largest factor-based strategy. Also read: How millennials can use these financial hacks to buy their first home While momentum investing holds high return potential, it also carries risks such as increased volatility and susceptibility to market corrections. Momentum indices manage these risks by adjusting for volatility and selecting the top-performing momentum stocks.