Factor Investing: Boosting Returns With Precision

Investors can't ignore factor indices as they keep beating benchmarks over long term

- Saurabh Mittal

Imagine you're shopping for shoes on Amazon. You start with thousands of options but gradually narrow your search using filters like category, colour, size and material until you find the perfect pair. This process mirrors the concept of factor investing: using specific criteria, or factors, to filter and select investments.

Factor-based index funds: Also known as smart beta or strategic index funds, are a sophisticated extension of passive investing. These funds invest in stocks that are part of indices created by NSE or BSE but with a twist. Traditional indices like the Nifty 50 or Sensex are built around companies' market capitalization, but factor-based indices use specific filters—such as momentum or low volatility—to refine the selection process.

In essence, these funds sit between active and traditional passive funds, retaining the transparency and cost efficiency of passive funds while incorporating some precision associated with active management.