Historical data suggests portfolios constructed on quality, value, growth, alpha, momentum, volatility were able to reward investors with better returns than that offered by market-cap based indices. Mutual fund houses are keen to launch ETFs that track the performance of the factor indices.
While investing, everyone who adheres to a clearly defined rule-based strategy stands a chance to make money. If the rules have stood the test of time, the odds of winning are even higher. Factor-based or smart beta exchange traded funds (ETF) adopt this rule-based approach of portfolio construction. They can be an interesting portfolio candidate for smart investors.
Historically, portfolios constructed on the factors or parameters such as quality, value, growth, alpha, momentum, volatility, tend to reward investors with returns in excess of that generated by market-cap based indices. These factors can be expressed numerically and a factor index can be crafted. For example, the quality score of a company is computed using debt to equity ratio, return on equity and EPS growth variability in five years. Companies are then sorted on the quality score parameter in a rule-based manner and then a basket of them is created to offer an index comprising high-quality stocks.
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 ..
