India market strategy: Quality and low volatility factors lead the way

Quality and Low Volatility factors are currently outperforming Momentum, High Beta, and Value strategies in the Indian market, according to the latest report by  PL Asset Management, the asset management arm of PL Capital-Prabhudas Lilladher.

Key Findings:

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  Nifty 200 Quality 30 and Nifty Low-Volatility 50 indices generated higher returns than the benchmark Nifty 50 in August.
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  The Nifty Alpha 50 (momentum factor) and Nifty 500 Value 50 underperformed the market.
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  PL Asset Management’s quantitative models suggest a transition towards a Low Volatility regime, indicating that less volatile stocks are expected to perform well.

In August, the Nifty 200 Quality 30 generated returns of 2.40%, while the Nifty Low-Volatility 50 delivered 1.73%, both exceeding the benchmark Nifty 50’s return of 1.14%. In contrast, the Nifty Alpha 50, which represents the momentum factor, returned just 0.31%. Meanwhile, the Nifty 500 Value 50 saw a decline of 1.19%, and the Nifty High Beta fell by 4.29%.

Analysing these trends, PL Asset Management’s advanced quantitative models indicate a shift in the market regime toward Low Volatility, suggesting that less volatile securities are poised to perform well. “This shift highlights that defensive factors and investment styles are currently outpacing more aggressive ones. Performance data from June and July hinted at a transition toward Quality and Low Volatility, which has now solidified as the regime shifted in August,” said the report.

Understanding Factor-Based Investing

Factor-based investing is an investment strategy that focuses on specific factors or characteristics that have historically driven stock returns. These factors can include:

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  Quality: Companies with strong financial health, good management, and sustainable business models.
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  Low Volatility: Stocks that exhibit lower price fluctuations compared to the overall market.
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  Momentum: Stocks that have been outperforming the market over a specific period.
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  Value: Stocks that are undervalued relative to their intrinsic value.
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  High Beta: Stocks that are more volatile than the overall market.
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  By focusing on these factors, investors can potentially achieve better risk-adjusted returns.

In the context of the PL Asset Management report, it suggests that stocks with strong fundamentals and lower volatility are currently performing better than those with high momentum or value characteristics. The shift towards a Low Volatility regime indicates that investors are favoring stocks with less risk and more stable returns.

According to PL Asset Management’s proprietary quant models, broader equity markets are expensive but not highly overvalued, with 45% of stocks trading above their 3-year average price-to-book ratio. The Nifty 50’s trailing P/E of 23.2x is 5% above its 3-year average. In contrast, small-cap and mid-cap indices trade at trailing P/E ratios of 31.6x and 43.6x, with premiums of ~12% and ~30% over their 3- year averages.

Equities remain the favored asset class, with 80% of stocks near their highs and the Nifty hitting new peaks in one-third of CY24 sessions, but PL Asset Management’s quant models indicate a global shift towards gold, which is gaining momentum.

Despite the unwinding of the Yen carry trade, which triggered a global market crash and a 2.5% decline in the Nifty 50 on August 5, the index swiftly rebounded, closing the month at new all-time highs. Investor sentiment remained positive, with the BSE market cap reaching record levels. Nifty Pharma and Healthcare were the best performing sectors in August, gaining 6.6% and 5.5%, signaling a shift to defensives.

The report also states that PL’s flagship AQUA PMS has achieved a return of 64% since its June 2023 launch, against the benchmark BSE 500 TRI 40.1%. This indicates an outperformance of 24%. In August, AQUA shifted allocation towards large and mid-cap stocks, now representing 75% of its portfolio.

AQUA’s portfolio has increased its allocation to non-cyclical sectors such as Healthcare, IT, Consumer Staples, and Consumer Discretionary, which now comprise approximately 70% of the total portfolio.  

In over a year since inception AQUA has exceeded the Rs 450 crore AUM (Assets Under Management) mark. 

“As per current market dynamics, we believe the strategy should be risk minimisation than return maximisation, which is why AQUA’s portfolio has become more defensive. AQUA’s success lies in its ability to adapt flexibly to changing market conditions, employing an unbiased, quantamental strategy for portfolio construction. This approach consistently delivers strong risk-adjusted performance through systematic processes,” said  Siddharth Vora, Head – Quant investment strategies & Fund Manager, PL Asset Management Executive Director, PL Capital- Prabhudas Lilladher. 

First Published: Sep 30 2024 | 9:29 AM IST