Factor ETFs: Why you should invest for long-term returns
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Mutual fund houses tend to launch ETFs that track the performance of the factor indices. Factor indices thus are placed in a sweet spot between passively managed ETFs and actively managed equity funds. These schemes charge less than actively managed equity funds towards expenses. Hence, they are cost-effective. While an actively managed diversified equity fund typically charges between 1% and 2.25% towards expenses, the factor ETFs charge around 30 basis points. ETFs tracking popular market-cap based indices such as Nifty 50, charge as low as 5 basis points.
Each factor goes through phases of underperformance. For example, in 2018-2020 value underperformed other factors. In 2018 and 2020 quality topped the performance chart. However, value came back with top of the chart performance in 2021-2023. Quality as a factor of investment, over 2021-2023, offered relatively less returns.
In some cases, the fund houses also offer to mimic an index constructed after combining two or more factors. For example, Nifty alpha low volatility 30 index or Nifty MidSmallcap 400 Momentum Quality 100 index. While the former screens stocks on the alpha and low volatility factors, the later picks up mid-small cap stocks based on momentum and quality factors.
Investors need to take a long-term view on these ETFs to materially benefit from them and should keep investing in them at regular intervals. Units of such ETFs can be held for a long term as a part of the core portfolio. Investors can also use these ETFs to complement their trading or investment style to achieve diversification. For example, an aggressive trader going after momentum trades, can park some money in the units of low volatility ETF. An investor keen on swing-trades in small cap stocks, may want to keep some money on ETFs tracking Nifty 50 Value 20 index. This index invests in the most attractively valued 20 stocks from the constituents of Nifty 50 index. Such an allocation leads to style diversification and it brings together uncorrelated or less correlated assets, which may improve risk adjusted returns.
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