There is Low Volatility ETF and a FoF (that invests in the ETF)
And there is a UTI momentum index fund now.
I have a favourable view on both the indices.
An investor asked: Which is better? Low Volatility ETF or Momentum Index fund? Should we invest in both? Easy question. Difficult answer.
This post is likely to leave you disappointed if you are looking for an objective answer. The decision will eventually boil down to your conviction. I just want to highlight some aspects on stock selection in these portfolios and that these portfolios (despite based on such contrasting strategies) may have a lot in common.
The Calendar Year Returns
I have compared just the calendar year performance of the Low Volatility and Momentum indices with Nifty 50. For detailed comparison between various factors between rolling returns/risk and drawdowns, refer to this post.
Since April 1, 2005 (until March 31, 2021), the Momentum index has given CAGR of 19.9% p.a. Nifty Low Volatility 30 index has returned 18.4% p.a. Nifty 50 has given 14.5% p.a.
You can see that the performance of both the factor indices is quite impressive. And purely from returns perspective, there is little to choose between the two indices.
You would expect the Low Volatility index to be less volatile than the momentum index. After all, momentum strategy picks stocks that are going places. Let’s look at rolling risk chart from one of the previous posts.
While Low Volatility index is less volatile, the momentum index does not take you for heart-stopping ride either. It is much less volatile than Value and Alpha factor indices. During some stretches, it does even better than Nifty 50 in terms of volatility.
Why does this happen?
Because the momentum index methodology has a volatility filter.
How are stocks selected in these factor indices?
The low Volatility index picks up the least volatile stocks. Right.
And momentum index picks up stocks that have done the best in the recent past. Not entirely true.
Momentum is not just about selecting stocks with the best price performance (picking up stocks that have risen the most during a given period). The path a stock takes during its rise to the top is important too.
Everything else being the same, the stock with a smoother rise gets a higher momentum score compared to the stock with a very volatile rise.
Suppose there are two stocks, A and B.
Stock A goes from Rs 50 to Rs 100. The path is: 50, 55, 60, 70, 65, 75, 85, 95, 100. (Smooth rise)
Stock B also goes from Rs 50 to Rs 100. The path is 50, 70, 85, 65, 55, 95, 70, 100. (Volatile rise)
We can see Stock A is much less volatile than Stock B and has had a much smoother rise from Rs 50 to Rs 100.
Therefore, Stock A will have a better momentum score than Stock B.
You can refer to stock selection methodology of various factor indices in this document.
And since momentum index methodology considers stock volatility, you can expect portfolio overlaps.
The Portfolio overlaps
A stock may not just rank well on one of the factors. A stock may rank well on many factors and may be a part of multiple indices.
For instance, there is an overlap of 11 stocks between Nifty 200 Momentum 30 index and Nifty 100 Low Volatility 30 index.
Between Nifty 200 Momentum 30 Index and Nifty Low Volatility 50 index, there is an overlap of 16 stocks.
Of course, we must look at a stock weights too, but I will skip such comparison in this post.
By the way, a common perception is that the Momentum index will have only junk stocks. That is not true either. I checked the overlap between Nifty 200 Momentum 30 index and Nifty 200 Quality 30 index. There were 11 common stocks. Another way to look at this: even quality stocks can be in momentum.
9 stocks present in all three (Momentum 30, Low Volatility 50 and Quality 30 indices).
This overlap shows that, even by investing in a single factor (momentum, low volatility), you get exposure to other factors too.
What to choose between Low Volatility ETF/FoF and Momentum index fund?
I do not have a crisp answer. Depends on your conviction.
There will be stretches of underperformance for these factor indices (or any strategy for that matter). Unless you have the conviction, you will likely bail out due to frustration. Therefore, if you must choose between Low Volatility and momentum, pick up the strategy you have greater conviction in and can stick with.
OR pick neither and stick simply with market cap-based indices.
OR pick both, if you have conviction in both the strategies.
If you must invest, consider factor indices as part of your satellite portfolio. These can be replacements for actively managed equity funds in your portfolio. Start small. As you develop comfort, you can increase exposure.
Points to Note
- Please understand this is NOT a recommendation to invest in either of these indices. There is no guarantee that Low Volatility or momentum indices will continue to beat market cap-based indices such as Nifty and Sensex.
- Much of the data for these factor indices is back-tested. Nifty Low Volatility 30 index was launched in July 2016 and the Nifty Momentum 30 index was launched in August 2020. The low Volatility index clearly has a much longer live data history than the momentum index. You can expect that, among all the ways to calculate low volatility or momentum score, the one with the best performance would have been chosen.
- I have used TRI data. The ETFs or the index funds will have expenses and tracking error. The expenses and tracking error may be higher for factor indices (compared to market cap-based indices).
- When serious money chases a particular strategy, you can expect the alpha to come down from these strategies.
9 thoughts on “Low Volatility ETF or Momentum Index Fund: Which one to choose?”
When comes to passive investing everyone recommends Index funds than ETF, The main reason is Liquidity , Price-Nav deviation in ETF, but Is Cost wise ETF is better than Index fund. ?
I have zerodha account and trading account, why not invest with ETFs for long term goals. Any major setbacks if i follow ETFs than Index funds for investment. If you have already published any post on ETF vs Index funds, kindly paste me the link here.
Hi Vandhiadevan,
If you can navigate through price-NAV issue and the liquidity is fine, ETFs are quite good. No issues there.
With Zerodha, you are fine with brokerage cost too.
I don’t have a post on this very topic.
The only problem I envisage with ETFs currently is: if you want to exit big amounts due to any reason, you might have to take a hit if the liquidity is not good. No such issues with index funds since you can sell back to the AMC.
Thanks, How to handle price-NAV issue in ETF. When you transact ETF, you can only deals with Price and Not NAV right ? I do not understand this price-nav issue and need some clarity on this subject.
Not easy to work around this issue.
Here is how you look at this.
Let’s say an ETF has only 2 stocks in equal weightage. Price of stock A is 40 and price of stock B is 50.
In that case, NAV of the ETF will be 50%*40 + 50%*50 = 45
NAV is the value of the underlying assets in the ETF.
Let’s say you want ot buy this ETF. Since the NAV of the ETF is 45, you would want to buy around that price.
However, what if the best offer (sell bid) is for 46?
You know that the correct value is 45 but the price you can buy at (or someone is willing to sell at) is 46.
And that’s the price-NAV problem.
Have touched upon this problem in this post (https://www.personalfinanceplan.in/etfs-exchange-traded-funds/).
Btw, most AMCs have information about real time NAV of their ETF on their websites. (here is one for ICICI AMC ETFs: https://www.icicipruamc.com/nav/etf)
You try to buy ETFs as close to real-time NAVs as possible. If you get for lower than NAV, good for you.
Hope this helps.
meticulous!
Very well-curated explanation, like always!
3 key take-aways from your article :
1. A stock may not just rank well on one of the factors. A stock may rank well on many factors and may be a part of multiple indices. So, sticking to one of the FACTOR-based index funds based on conviction is enough.
2. Add these factor-based funds as your satellite portfolio and then based on comfort, increase exposure and replace active funds in your portfolio.
3. Expense ratio along with tracking error will be higher in factor-based index funds compared with market cap-based indices.
Thanks Sumanas!
Well summarized.
About factor-based indices, I am not saying that one must stick to just one. The key is to have conviction. If you have in a couple, go ahead.
But it’s not easy to have conviction about multiple factors.
Btw, not good to have conviction about too many factors either because the net result (of all the factors) will likely be average.
Thanks for simple and powerful explanation on Price-Nav. Now i am clear on this. I have started with Smallcase All weather investing portfolio which invest in 4 ETF (Nifty bees,Junior Bess,Liquid bees and Gold bees). But the problem is all the buy/sell of these ETFS by smallcase is market order (not limit order). So there is no choice for an investor to know whether the Price-NAV has been taken care during BUY/SELL.
Even if i do it on my own by resembling the portfolio, the bit heavy work like need to look the price which is close NAV every time for these 4 ETFs. But if i plan to long term goals, then its become tedious procedure for every month for long term. This is one area , i have limitation to use ETF and should stick to Index funds
Market order, especially for ETFs is a serious problem with Smallcase.
Would rather work with index funds or FoFs.
Hi Deepesh, as usual you are best in the game. Thanks for this.
What is the reason you are choosing Nifty 500 Value 50 index which does not have any ETF nor Index funds in real, why not use Nifty 50 Value 20(NV20) which has ETFs as well as Index funds now(from Nippon)
NV20 Index has been a reall good performer compared to N500 Value 50.
Please have NV20 index as a comparision with other factor indexes. This will give the true picture.
Can you also have a study on the Mixing Nifty 50 Value 20 and Momemtum index as both follows a opposite pattern and can be a part of a barbell portfolio.
Thank you in Advance.