Friday, September 19 2025
Source/Contribution by : NJ Publications

The world of investing is changing rapidly, and at the heart of this transformation lies Factor-based Funds - a new-age approach where mathematics, data, and algorithms take the driver’s seat. Unlike traditional funds that rely heavily on human judgment, Factor-based Funds use sophisticated models to analyze vast amounts of financial data and identify patterns invisible to the human eye. The goal is to make consistent, calculated investment decisions by mitigating the influence of human biases and emotions.

Think of it as a research team that never sleeps - scanning thousands of company reports, market movements, and global indicators simultaneously, all without emotion. The result? Investment decisions are objective, systematic, and data-driven.

Why Factor-based Funds are Gaining Popularity

• Transparency & Discipline - Decisions are based on rules, not gut feelings.

• Eliminating Bias - Human emotions often cloud judgment; algorithms don't.

• Accessibility - Growing computing power and data availability have made Factor-based strategies mainstream.

• Consistency - Factor-based models aim for steady performance across market cycles.

How Do Factor-based Funds Work?

Factor-based funds build their portfolios by employing a factor investing strategy. This means they select securities based on specific, return-driving characteristics, or "factors," such as:

• Value: Targeting stocks priced lower than their intrinsic value, using metrics like the price-to-earnings (P/E) ratio.

• Momentum: Capitalizing on the trend of stocks that have recently outperformed, based on the observation that strong past performance often continues in the short to medium term.

• Quality: Focusing on companies with strong financial fundamentals, such as high profitability and low debt levels.

• Size: Recognizing the historical tendency for smaller companies to outperform larger ones over the long term.

• Low Volatility: Selecting stocks with lower price fluctuations to provide stable returns and reduce risk.

The models used by Factor-based funds are rigorously back-tested against historical market conditions to ensure their robustness. A fund may use a single factor or combine multiple factors to build a diversified portfolio.

Different Types of Factor-based Funds

1. Single-Factor Funds - These funds focus on one particular factor when choosing stocks. A Value Factor Fund may only pick stocks that look undervalued If that one factor does well, the fund performs strongly. But if the factor struggles, returns may be weak.

2. Multi-Factor Funds - Instead of relying on one factor, these funds combine two or more factors (like value + momentum, or quality + low volatility). A fund might buy only those companies that are both undervalued (value) and have low debt (quality). This helps balance risks - if one factor underperforms, another may support the portfolio.

3. Quantamental Funds - These funds combine the power of algorithms with human insights. The computer screens thousands of stocks using rules, but the fund manager may apply judgment before final selection.

4. Active Smart Beta Funds - Active Smart Beta strategies uniquely blend the rigorous discipline of rule-based investing with the adaptable nature of active management. While these funds utilize a systematic, factor-based approach, a crucial differentiator is the fund manager's discretion in defining the rules governing portfolio construction. This inherent flexibility in tailoring and evolving these rules provides Active Smart Beta funds with enhanced potential to outperform traditional factor indices over time.

5. Passive Smart Beta Funds - These are index-linked Factor-based strategies (often via ETFs or index funds) that may use alternative weighting - based on factors like value, low volatility, or momentum - instead of market cap.

What It Means for Investors

Factor-based Funds open new doors for investors who want to:

• Minimize bias in decision-making

• Gain exposure to disciplined factor-based investing

• Access strategies once limited to global hedge funds

• Build portfolios that are adaptive, data-driven, and future-ready

In short, Factor-based Funds are not just a passing trend. They represent the future of investing, where human intuition and machine intelligence come together to create smarter, more resilient portfolios.

Disclaimer: Mutual Fund investments are subject to market risks, read all the scheme related documents carefully.