Factor-based funds are becoming popular in India as these funds offer the benefits of both active and passive investing. Passive because they track their underlying index, and active because they invest in a selected few based on a predefined rule or a factor. That is why they are called factor funds. They regularly track and review the index and rebalance the portfolio to meet their criteria. These funds do not have fund managers’ biases but aim to offer better returns than the underlying index.

Which Factors These Funds Commonly Consider?

Factor funds set their criteria based on momentum, value, quality, growth, and volatility, among other aspects. The momentum is about selecting the stocks within the underlying index that have been performing well and are expected to continue in future. Value, on the other hand, focuses on selecting undervalued stocks. Similarly, for quality factor, companies with strong financials and fundamentals are chosen. Growth and volatility factors are considered to assess stocks based on growth potential and less volatile price movement, respectively.

According to the NSE India website, there are currently 35 factor-based indices. However, factor funds are not always single-factor-based, there are multiple or multi-factor funds also in the market.

Who Can Invest In Them?

They do not target any specific segment of investors. Anyone who wants to gain exposure to the market based on factors can invest in these funds.

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Are Multiple-Factor Funds Better Than Single-Factor Funds?

There is no factor that can perform well in all market phases. One may work in a low market phase, while the other may work during recovery. The markets are uncertain and cyclical; thus, experts suggest diversifying the investment across asset classes, investment periods, and risk profiles.

Harsh Gahlaut, Co-founder and CEO of FinEdge, says, “Single-factor funds carry higher risk as these funds have a concentrated portfolio based on a singular condition. Multiple-factor funds carry diversified risk owing to more than one parameter or factor they invest in. Moreover, single-factor funds could see longer periods of underperformance due to their tendency to be cyclical.”

He suggests that multi-factor is generally better because of a diversified approach. However, ultimately, people should choose based on their investment goals, risk tolerance, and investing expectations.

What Should You Consider Before Investing In Them?

Before investing in any scheme, guaranteed or market-oriented, one should understand the risks involved, the time needed to stay invested, charges for premature withdrawals, etc., and accordingly align with individual goals. Since equity is riskier than guaranteed income instruments, they should be ready to take risks. Even with equities, they should try to understand the associated risks across various plans.

Should Senior Citizens Invest In These Funds?

Gahlaut says, “Factor funds often require a long-term commitment, typically 5-10 years, to see through market cycles and potential underperformance periods.” So, these funds may not be ideal for seniors due to their volatility and associated risks. Besides, the cyclical nature of factors can also lead to significant fluctuations in the portfolio value, not aligning with their time horizon and financial goals, he adds.

Since these funds are not fully active but based on an index, shouldn’t they be suitable for risk-averse investors?

Gahlaut explains index funds have a benchmark like the Nifty 50 or the Sensex. Index funds offer broader market exposure and carry less risk than factor-based funds. Factor funds go through market cycles, and their concentrated exposure based on certain factors makes them riskier if the factor doesn’t perform well. While a multi-factor approach could mitigate the risk, it still is not as diversified as the broad-based index funds.

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Usually, seniors don’t earn in their retirement years and live on pensions or some other passive income. So, they may not like to invest in riskier avenues or for the long term. Gahlaut suggests, “Senior citizens might be better served by consulting an expert who could take into account the individual’s risk profile, investing horizon and income needs and recommend suitable investments such as debt mutual funds or other low-risk instruments that offer stability and consistent income.”

As factor funds are rule-based, they remove the human bias of a fund manager and are less expensive than active funds, where the fund manager makes key decisions. However, investors should consult an expert if they are exploring these funds for investments.