Factor Analysis in Indian Markets: A Comprehensive Study (2005-Present)
In the ever-evolving landscape of Indian financial markets, understanding the performance of various factor strategies is crucial for investors and fund managers alike. This article presents a comprehensive analysis of different factor indices in India since 2005, offering insights into their relative performance against the NIFTY 50 benchmark.
Methodology
Our analysis involved calculating 3-year rolling returns for each factor index and subtracting the corresponding 3-year rolling returns of the NIFTY 50 benchmark. We then plotted the distribution of excess returns for each factor index and ranked them based on several key metrics:
1. Percentage of days with positive excess returns
2. 25th percentile value of excess returns
3. Average 3-year rolling return
4. Sharpe ratio
5. Maximum drawdown
Key Findings
1. Multi-Factor Strategies: Top Performers
The NIFTY MIDSMALL400_MomentumQuality100 emerged as the top performer, showcasing strong consistency and risk-adjusted returns. It outperformed the benchmark 84% of the time and boasted a high Sharpe ratio of 1.81.
Distribution of top multi-factor performers:
NIFTY MIDSMALL400_MQ100:
— CAGR (SI): 36.61%
— 3 Yr Rolling Return (CAGR): 20.10%
— % Outperformance: 84%
— Top 25% Excess Return: 13.38%
— Sharpe Ratio: 1.81
NIFTYSMALL250_MQ100:
— CAGR (SI): 36.00%
— 3 Yr Rolling Return (CAGR): 20.43%
— % Outperformance: 77%
— Top 25% Excess Return: 16.11%
— Sharpe Ratio: 1.65
2. Momentum Strategies: Consistent Performers
Momentum factors showed impressive results, with NIFTY MID150_M50, NIFTY 500_M50, and NIFTY 200_M30 all ranking high in our analysis. These strategies consistently outperformed the benchmark and demonstrated robust risk-adjusted returns.
Distribution of top momentum performers:
NIFTY MID150_M50:
— CAGR (SI): 38.25%
— 3 Yr Rolling Return (CAGR): 21.94%
— % Outperformance: 79%
— Top 25% Excess Return: 18.45%
— Sharpe Ratio: 1.80
NIFTY 500_M50:
— CAGR (SI): 37.34%
— 3 Yr Rolling Return (CAGR): 19.45%
— % Outperformance: 82%
— Top 25% Excess Return: 13.25%
— Sharpe Ratio: 1.65
NIFTY 200_M30:
— CAGR (SI): 32.70%
— 3 Yr Rolling Return (CAGR): 17.99%
— % Outperformance: 86%
— Top 25% Excess Return: 9.82%
— Sharpe Ratio: 1.44
3. Low Volatility Strategies: Risk averse
Both NIFTY_L50 and NIFTY100_L30 showed strong performance, particularly in terms of downside protection. They had lower maximum drawdowns compared to most other strategies while maintaining competitive returns.
Distribution of top low volatility performers:
NIFTY_L50:
— CAGR (SI): 27.55%
— 3 Yr Rolling Return (CAGR): 15.69%
— % Outperformance: 77%
— Top 25% Excess Return: 7.49%
— Sharpe Ratio: 1.67
NIFTY100_L30:
— CAGR (SI): 27.53%
— 3 Yr Rolling Return (CAGR): 15.50%
— % Outperformance: 80%
— Top 25% Excess Return: 5.54%
— Sharpe Ratio: 1.59
4. Quality Factors: Mixed Results
Quality strategies showed mixed results. While they demonstrated good downside protection, their outperformance was less consistent compared to momentum and multi-factor strategies.
Distribution of top quality performers:
NIFTY SMALL250_Q50:
— CAGR (SI): 31.29%
— 3 Yr Rolling Return (CAGR): 19.08%
— % Outperformance: 72%
— Top 25% Excess Return: 15.28%
— Sharpe Ratio: 1.60
NIFTY MIDCAP150_Q50:
— CAGR (SI): 29.54%
— 3 Yr Rolling Return (CAGR): 18.12%
— % Outperformance: 77%
— Top 25% Excess Return: 12.67%
— Sharpe Ratio: 1.65
5. Alpha Factors:
Alpha strategies showed high volatility and significant maximum drawdowns, despite occasional strong outperformance. This suggests they may be more suitable for investors with higher risk tolerance.
Distribution of top alpha performers:
NIFTY_A50:
— CAGR (SI): 32.20%
— 3 Yr Rolling Return (CAGR): 17.61%
— % Outperformance: 74%
— Top 25% Excess Return: 13.00%
— Sharpe Ratio: 1.29
NIFTY200_A30:
— CAGR (SI): 30.23%
— 3 Yr Rolling Return (CAGR): 16.11%
— % Outperformance: 75%
— Top 25% Excess Return: 10.79%
— Sharpe Ratio: 1.23
6. Value Strategies: Underperformers
Surprisingly, value strategies like NIFTY200_V30 and NIFTY500_V50 underperformed in our analysis. They showed the lowest percentage of days outperforming the benchmark and had the highest volatility among all factors studied.
Distribution of value performers:
NIFTY500_V50:
— CAGR (SI): 26.93%
— 3 Yr Rolling Return (CAGR): 15.33%
— % Outperformance: 55%
— Top 25% Excess Return: 14.19%
— Sharpe Ratio: 1.02
NIFTY200_V30:
— CAGR (SI): 26.80%
— 3 Yr Rolling Return (CAGR): 14.85%
— % Outperformance: 50%
— Top 25% Excess Return: 13.33%
— Sharpe Ratio: 1.00
Summary & Ranking of various Factor strategies
Score for each Factor Strategy is given on below basis
20% weightage to 3 Yr RR (CAGR) — 3 year average rolling returns
20% weightage to % of Outperformance — # of 3 year periods which had generated excess returns over NIFTY 50 / Total count of 3 year periods
40% weightage to Bottom 25% ile excess returns — The worst case scenario for every investor, if the investor is able to generate alpha in the worst case as well then its a good strategy.
10% weightage each to Maximum DrawDown and Sharpe Ratio
Implications for Investors
1. Diversification Benefits: The strong performance of multi-factor strategies underscores the importance of diversification across different factors. The NIFTY MIDSMALL400_MQ100, with its high outperformance rate and Sharpe ratio, illustrates the potential of well-constructed multi-factor approaches.
2. Momentum’s Strength: The consistent outperformance of momentum strategies in the Indian market suggests that trend-following approaches have been particularly effective. The NIFTY MID150_M50 and NIFTY 500_M50, with their high CAGR and outperformance rates, stand out as strong momentum plays.
3. Risk Management: Low volatility strategies’ strong showing highlights the importance of considering downside protection, especially in emerging markets like India. While the NIFTY_L50 and NIFTY100_L30 may not have the highest returns, their consistent outperformance and higher Sharpe ratios make them attractive for risk-averse investors.
4. Quality and Size Effect: The performance of quality factors, particularly in small and mid-cap segments (NIFTY SMALL250_Q50 and NIFTY MIDCAP150_Q50), suggests that quality metrics may be especially relevant in these market segments.
5. Caution with Value: The underperformance of value strategies calls for careful consideration when implementing value-based approaches in the Indian market context. The low outperformance rates of NIFTY500_V50 and NIFTY200_V30 indicate that traditional value metrics may not have been as effective in the Indian market during this period.
6. Alpha Strategies for Active Investors: While alpha strategies showed high volatility, their occasional strong outperformance (as seen with NIFTY_A50) might appeal to more active investors willing to accept higher risk for potential higher returns.
Conclusion
Our comprehensive analysis reveals that multi-factor and momentum strategies have been particularly effective in the Indian market since 2005. The strong performance of these strategies, exemplified by indices like NIFTY MIDSMALL400_MQ100 and NIFTY MID150_M50, suggests that combining factors or following strong trends has been a successful approach in the Indian equity market.
However, the mixed performance across different factors underscores the importance of a nuanced approach to factor investing. While momentum and multi-factor strategies have shown strong results, the effectiveness of value strategies has been limited, and quality factors have shown varying results depending on the market segment.
Investors and fund managers should consider these findings when constructing portfolios, keeping in mind that past performance doesn’t guarantee future results. The outperformance of low volatility strategies also highlights the importance of risk management in portfolio construction.
Regular review and rebalancing of factor exposures, along with a keen eye on market conditions, will be crucial for navigating the complex landscape of Indian equity markets. As the market evolves, the relative performance of these factors may change, necessitating ongoing analysis and adjustment of investment strategies.
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- Note: This analysis is based on historical data and should not be considered as investment advice. Always consult with a financial advisor before making investment decisions.*
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