In an earlier post, we discussed factor-investing and compared the performance of various factor indices (Value, Momentum, Quality, Low Volatility, and Alpha). The performance of some of the factors especially, Quality, Low Volatility, and Momentum was impressive, both on risk and return front.
What if we combine two factors?
Or what if we pick those stocks that rank well on 2 (or more) factors? For instance, Alpha and Low Volatility. How does the performance look?
NSE has released 4 multi-factor indices until now.
Why would you combine two factors?
Nothing works all the time. And this can apply to factor investing too.
By selecting stocks that rank well on two factors (say Factor A and B), the hope is that when Factor A is not working, Factor B will do the heavy-lifting and manage the performance.
Note there is no guarantee of a combination of factors A and B being better than A and B individually. Of course, it may appear so in the back-tests.
What does the data tell us?
In this post, I consider a multi-factor index (Nifty Alpha Low Volatility 30 index) and compare its performance against single factor indices (Nifty Alpha 50 and Nifty 100 Low Volatility 30) and Nifty 50.
Let’s look at the performance of individual factors since 2005.
While Alpha has delivered good long-term performance, it has had a few very bad years (2008, 2011, 2016 and 2018). I think, by combining Alpha with Low Volatility, the creators hope to improve performance in down years.
What is Nifty Alpha Low Volatility 30 Index?
I reproduce the excerpt from NiftyIndices website.
Nifty Alpha Low-Volatility 30 Index is designed to reflect the performance of a portfolio of stocks selected based on top combination of Alpha and Low Volatility. It intends to counter the cyclicality of single factor index strategy and provides investors a choice to take exposure to multiple factors through a single index product.
The Index consists of 30 stocks selected from NIFTY 100 and NIFTY Midcap 50. The weight of the stocks are derived from Alpha and Low Volatility factor scores with individual stock weight capped at 5%.
The index is rebalanced on a semi-annual basis.
Nifty Alpha Low Volatility: Performance Comparison
I compare the performance of the following 4 indices.
- Nifty Alpha Low Volatility 30 TRI
- Nifty 50 TRI
- Nifty Alpha 50 TRI
- Nifty 100 Low Volatility 30 TRI
We compare the performance since April 1, 2005.
Note that Nifty Alpha 50 was launched in November 2012. Nifty 100 Low Volatility 30 was launched in July 2016. Nifty Alpha Low Volatility 30 was launched in July 2017.
Thus, much of the data for the Nifty Alpha Low Volatility 30 index is back-tested. You must consider this aspect. The good results of this index could be result of data-mining.
Nifty Alpha Low Volatility 30 has been the best performer. Here is the CAGR from April 1-2005 until October 1, 2020.
Nifty Alpha Low Volatility 30 TRI: 19.08% p.a.
Nifty 50 TRI: 13.07% p.a.
Nifty Alpha 50 TRI: 17.59% p.a.
Nifty 100 Low Volatility 30 TRI: 17.40% p.a.
If we consider the data from the index inception date (July 10, 2017-October 1, 2020), Rs 100 invested in the 4 indices would have grown to
Nifty Alpha Low Volatility 30 TRI: Rs 131.7
Nifty 50 TRI: Rs 121.6
Nifty Alpha 50 TRI: Rs 147.6
Nifty 100 Low Volatility 30 TRI: Rs 131.8
While the live data for 3 years is too short to reach any conclusion, the 2-factor index (Nifty Alpha Low Volatility index) has not set things on fire. Single factor indices (Alpha 50 and Low Volatility) have done better or at least as well.
This shows up in the calendar year returns too.
What about Volatility and drawdowns?
Nifty Alpha Low Volatility 30 does well on the volatility and drawdown front too. You can see that the Nifty Alpha Low Volatility Index has been able to avoid the heavy drawdowns of Nifty Alpha 50 index.
The Caveats/Points to Note
- If we look at calendar year returns, Nifty Alpha Low Volatility 30 looks a fine bet. However, we have too little data to reach a conclusion. Live data is only for 3 years.
- NSE has two single factor indices for Alpha: Nifty Alpha 50 (picks from top 300 stocks by free-float market cap) and Nifty 100 Alpha 30 (picks from top 100 stocks)
- NSE has two single factor indices for Low Volatility: Nifty Low Volatility 50 (picks from top 300 stocks by free-float market cap) and Nifty 100 Low Volatility 30 (picks from top 100 stocks)
- You would expect that the Nifty Alpha Low Volatility 30 will pick from either top 100 stocks or top 300 stocks. Instead, for this index, only Nifty 100 and Nifty Midcap 50 form part of the consideration set. Hence, the consideration set is top 150 stocks. Not 100. Not 300.
- Why 150 and not 100 or 300? We don’t know. Perhaps a case of data mining.
- There is an ETF (ICICI Prudential Alpha Low Vol 30 ETF) available that tracks Nifty Alpha Low Volatility 30 index.
What should you do?
I am not very comfortable with multi-factor indices as of now. It is a kind of hotch-potch. It is difficult to have conviction with such products. It is possible that my opinion may change in the future. Until such time, if I must, I am more comfortable with investing in single factor indices.
What about you?
Test Results of other Investment Strategies
Over the past few months, we have tested various investment strategies or ideas and compared the performance against the Buy-and-Hold Nifty 50 portfolio. In some of the previous posts, we have:
- Assessed whether adding an International Equity Fund and Gold to an Equity portfolio has improved returns and reduced volatility.
- Does Momentum Investing work in India?
- Does Low Volatility investing beat Nifty and Sensex?
- Nifty 200 Momentum 30 Index: Performance Review
- Nifty Factor Indices (Value, Momentum, Quality, Low Volatility, Alpha): Performance Comparison
- Considered the data for the past 20 years to see if the Price-Earnings (PE) multiple tells us anything about the prospective returns. It does, or at least has in the past.
- Tested a momentum strategy to shift between Nifty 50 and a liquid fund and compared the performance against a simple 50:50 annual rebalanced portfolio of Nifty index fund and liquid fund.
- Used a Simple Moving Average Based Market Entry and Exit Strategy and compared the performance against Buy-and-Hold Nifty 50 over the last two decades.
- Compared the performance of Nifty Next 50 against Nifty 50 over the last two decades.
- Compared the performance of Nifty 50 Equal Weight vs Nifty 50 vs Nifty 50 over the last 20 years.
- Nothing works all the time. Used Nifty 50, Nifty MidCap 150 and Nifty Small Cap 250 index to demonstrate that sometimes intuitive investment choices do not work.
- Compared the performance of 2 popular balanced funds against a simple combination of an index fund and a liquid fund.
- Compared the performance of a popular dynamic asset allocation fund (Balanced advantage fund) against an equity index fund and see if it has been able to provide reasonable returns at low volatility.