Weekly Musings – NFO Pick (Edelweiss Nifty Alpha Low Volatility 30 Index Fund)

30 Apr 2024 , 10:05 AM

WHY FACTOR FUNDS, AND WHY ALPHA LOW VOLATILITY?

The Edelweiss Nifty Alpha Low Volatility 30 Index Fund NFO is a classic factor fund, which lies somewhere between a passive fund and an active fund. Like a passive fund, the factor fund is also based on an underlying index. However, like an active fund, the underlying index is actively managed. Hence, such factor funds are considered to be more risky than pure passive funds, but less risky than active funds. Unlike active funds, these factor funds are also benchmarked to an underlying index and hence there is limited fund manager discretion. The role of the fund manager is limited to managing tracking error.

The factor funds are based on a variety of themes like volatility, quality, alpha, momentum etc. Then there are also the combinations like Alpha Low Volatility. They are a more granular form of an index. The Edelweiss Nifty Alpha Low Volatility 30 Index Fund is actually a combination of the Alpha factor and the low volatility factor. In other words, the passive portfolio looks at stocks that will have low volatility, but would still delivery alpha. The Alpha Low Volatility funds are known to have outperformed other categories of factor due to their ability to combine return enhancement and risk management.

ALPHA LOW VOLATILITY FACTOR STRATEGY HAS WORKED EMPIRICALLY

To understand whether the Alpha Low Volatility factor strategy works, let us look at comparisons of returns and risk adjusted returns. Here are some quick findings.

• If you compare alpha low volatility with other factor strategies; then alpha low volatility has outperformed over 50% of the other themes across 1 year, 3 year, 5 year and 10 year time frames.
• If you compare the returns of the Nifty Alpha Low Volatility 30 TRI with the Nifty 100 TRI and the Top 5 large cap funds, then the Nifty Alpha low Volatility index is an outperformer across all short term and long term time frames.
• If you compare the Nifty Alpha Low Volatility TRI index with a large cap fund portfolio, then the former has a higher Sharpe Ratio, flat volatility and a sharply higher Sortino ratio. The Sortino ratio measures additional return earned for each unit of downside risk assumed by the investor.
• If you compare the annual returns of the Nifty Alpha Low Volatility TRI index with the Nifty 100 TRI, then in 8 out of the 10 years, the Nifty Alpha Low volatility fund has outperformed and has underperformed only in 2 years.
• Even if you set aside lumpsum investing and focus on SIP investing, then the Nifty Alpha Low Volatility TRI Index has done better than the Nifty 100. It has outperformed in a 5-year SIP by 590 bps while over a 10-year period it has outperformed by 410 basis points.

WHAT EXACTLY WILL THIS MULTI-FACTOR FUND DO?

Factor investing is relatively complex and hence it would be instructive to understand what goes into the index creation. Here are a few key takeaways.

• The starting point is a combination of top 150 large and mid-cap stocks. These are the stocks that have recently outperformed the broader market and are also less volatile. Out of this universe of 150 stocks, 30 stocks are selected.
• The fund will create a predominantly large cap portfolio to outperform market based indices and also to outperform broader indices and a typical large cap portfolio. Here alpha is about pro-cyclical factors, excess returns and outperforms in upside. Low volatility focuses on stocks that are more defensive and drives better risk adjusting returns in the long run by outperforming in a falling market.
• Let us understand the process for index creation in this case. Out of the universe of 150 large and mid-cap stocks, 30 stocks are selected. Alpha is based on high Jensen Alpha in last one year while low volatility is based on standard deviation. The top 30 stocks are all assigned equal weightage and weights are assigned based on a comprehensive score. This index is reviewed and rebalanced every 6 months to remain current.

PERFORMANCE OF PASSIVE FACTOR FUND PROXIES IN INDIA

Here is a quick look at the open ended factor fund proxies in India as of April 26, 2024. These are CAGR returns for beyond 1 year, and pertain to regular plans. Factor funds are a mix of active and passive funds and offer above market returns with lower levels of risk. There are several factor funds in India so we have restricted to 15 such factor funds that have a similarity with the NFO.

Scheme Name	1 Year (%) Returns	Launch (%) Returns	AUM (₹ Crore)
Aditya Birla Sun Life Nifty 200 Momentum 30 ETF	70.14	37.74	50.46
Aditya Birla Sun Life Nifty 200 Quality 30 ETF	32.46	16.52	39.62
Bandhan Nifty100 Low Volatility 30 Index Fund	32.87	22.17	579.59
Bandhan Nifty200 Momentum 30 Index Fund	67.94	34.65	71.14
Edelweiss Nifty 100 Quality 30 Index Fund	34.30	11.10	28.49
HDFC NIFTY100 Low Volatility 30 ETF	35.23	25.70	8.04
HDFC NIFTY100 Quality 30 ETF	35.09	21.55	11.90
HDFC NIFTY200 Momentum 30 ETF	69.57	40.92	27.61
ICICI Prudential Nifty50 Value 20 ETF	36.30	18.21	127.47
ICICI Prudential Nifty Alpha Low- Volatility 30 ETF	52.92	25.12	924.55
Kotak Nifty 50 Value 20 ETF	36.59	18.05	65.28
Kotak Nifty Alpha 50 ETF	83.93	16.16	119.98
Mirae Asset Nifty 100 Low Volatility 30 ETF	35.22	36.27	9.23
Nippon Nifty Alpha Low Volatility 30 Index Fund	52.09	30.26	305.52
SBI Nifty 200 Quality 30 ETF	32.15	14.72	79.54

Data Source: AMFI India

In the table above, we have selected a cross section of 15 funds that represent the factor funds like alpha, low volatility, momentum, alpha-low volatility, quality etc. However, the risk profile is approximately the same in most cases. These comparisons are purely for the purpose of understanding and not meant for any decision marking. Only 1 year returns and returns since inception have been considered in this case.

• The return dispersion is fairly high in this case and that is largely because many of these factor strategies themselves are quite heterogenous in nature. On a 1-year returns basis, factor funds in India generated maximum returns of 83.93% and minimum returns of 32.15%, showing rather wide variations due to the varied nature of factor funds in India. The average returns over a 1 year period are 47.12%, which is fairly impressive. However, it must be noted here that the said scheme is a factor fund which is exposed to the risk of tracking error and of wrong index selection.
• Based on returns since launch, the proxies for factor funds in India generated maximum returns of 40.92% and minimum returns of 11.10%, showing fairly attractive base case returns, despite the wide returns variations. The average returns since launch were 24.61%. While these are proxies of factor funds, they may not directly be comparable with the current fund, which is a unique combination of alpha and low volatility.

The strategy has done very well over a shorter time frame, but it appears to be normalizing over a longer period. One has to make a risk-return trade-off in the case of a factor fund and its benefits vis-à-vis a pure passive or a pure active funds.

GLANCE AT THE EDELWEISS NIFTY ALPHA LOW VOLATILITY 30 INDEX FUND NFO

Here are some details of the Edelweiss Nifty Alpha Low Volatility 30 Index Fund NFO you must know to decide on investing in the fund.

The NFO of Edelweiss Nifty Alpha Low Volatility 30 Index Fund opens for subscription on April 26, 2024 and will close on May 10, 2024. Being an open-ended equity scheme, the fund will offer buy and sale at NAV linked prices and will reopen for sale and repurchase within 10 days of NFO closure. While the fund has no lock-in period, it is best to hold such thematic funds for a period of 5-7 year or more to get full factor investing benefits.
On the Standard SEBI Risk-O-Meter, the Edelweiss Nifty Alpha Low Volatility 30 Index Fund will be ranked as a Very High Risk Fund, despite being a passive factor fund. The high risk is due to the predominant exposure to equities that the Edelweiss Nifty Alpha Low Volatility 30 Index Fund will have. In addition, there is also the risk of entering into the fund when the market is at all-time highs. While it is a passive fund, it is also a factor fund so there will be churn in the index. Also, the structure of the index is something the fund has no control over.
The Edelweiss Nifty Alpha Low Volatility 30 Index Fund is about long term capital appreciation with the combination of alpha and low volatility. This theme has been observed to outperform other factor themes in India on a consistent basis. Being a passive factor fund, the only focus of the fund manager will be to manage the tracking error. The portfolio will change in tandem with the underlying factor index.
Investors can invest in the NFO of Edelweiss Nifty Alpha Low Volatility 30 Index Fund in minimum size of ₹100 and in multiples of ₹1 thereof. This also applies to switch-ins during the NFO and additional purchases. There will be no exit load on the fund irrespective of when it is redeemed. However, investors are advised to hold such funds for a minimum period of 5-7 years to get full benefits of the factor playing out.
The Edelweiss Nifty Alpha Low Volatility 30 Index Fund does not give any guarantee on returns, being a pure equity factor fund, pegged to a factor index. The fund will maintain 80-100% exposure to equities, while the balance may be spread across debt and liquid assets. As the name of the fund suggests, it will be benchmarked to the underlying Nifty Alpha Low Volatility 30 – TR Index. The focus of the fund manager would be more to manage the tracking error.
The Edelweiss Nifty Alpha Low Volatility 30 Index Fund NFO will offer the growth option as well as the IDCW (income distribution capital withdrawal) payout option. It will offer the facility to invest via the Regular Plan or through the Direct plan. The NAVs on redemption will be different for regular plans and dividend plans based on the TER imputed to the fund. The NAVs of growth plan and IDCW plan will differ to the extent of dividends declared.
The fund is best suited for investors with a higher risk appetite and the ability to stay invested for a period of 5-7 Investors in the Edelweiss Nifty Alpha Low Volatility 30 Index Fund NFO must be prepared for the additional risk of a factor play based on a combination of fundamentals and quants. While this strategy is supported by empirical evidence, there is no guarantee of returns.
The Edelweiss Nifty Alpha Low Volatility 30 Index Fund will be benchmarked to the Nifty Alpha Low Volatility 30 - TRI. The TRI (total returns index) is more reflective as it includes the impact of dividends and capital movement. This benchmarking is used to evaluate whether the fund is underperforming or outperforming the underlying benchmark. The fund manager for the Edelweiss Nifty Alpha Low Volatility 30 Index Fund will be Bhavesh Jain.The Edelweiss Nifty Alpha Low Volatility 30 Index Fund will be classified as an equity fund for tax purposes; with its equity exposure decisively above 65%. The short term capital gains (held for less 1 year) will be taxed at 15% while long term capital gains (held for over 1 year), will be taxed at a flat rate of 10% beyond a minimum threshold exemption of ₹1 Lakh per financial year.

The Edelweiss Nifty Alpha Low Volatility 30 Index Fund NFO is an opportunity for investors to participate in the in a combination of two factors viz. low volatility and alpha. That seems to be a rather tough combination but there are enough stocks available, which have made this fund portfolio quite interesting. Investors can look at this NFO, not only to add a factor fund to the satellite portfolio, but also to manage the equity / debt mix in the portfolio with the adept use of index funds.