Nifty Alpha Low Volatility 30: A smart mix of factors

In recent months, the equity markets have turned quite volatile with most indices getting on a corrective mode. A combination of high valuations, slowing economic growth, extensive FPI selling and underwhelming corporate results are at play.

Given the choppy markets, investors would seek a better performance than standard benchmarks, but without too much volatility.

Factor investing combines the best of passive and active styles. Following a rule-based approach may be ideal for achieving risk-adjusted returns with low fluctuations.

Thus, combining the alpha and low volatility factors, for such an outcome would work best for investors.

That is precisely what the Nifty Alpha Low Volatility 30 index (Nifty Alpha Low Vol 30) manages to do.

This multi-factor index may be well-suited for long-term investments when done via the ETF (exchange traded fund) route.

Combining two styles

Alpha represents the excess returns over any specific benchmark such as an equity index. This factor is typically represented by stocks that have demonstrated strong outperformance against benchmarks, and are usually driven by momentum. In a cyclically driven market rally, alpha factor stocks tend to do well.

Usually, Jensen Alpha is used to filter such stocks. Jensen Alpha tells us whether an investment (stock etc.) is generating adequate returns for the risk taken.

On the other hand, a low volatility strategy involves buying stocks or an index of such stocks that have a fair degree of stability in their price movements. Lower volatility means lower fluctuations, lower uncertainty and lower risks compared to the broader markets.

It is a defensive factor and over the long term, it is geared to generate better risk-adjusted returns. The low volatility factor usually outperforms during weak market cycles. Low volatility stocks and indices fall a lot less than the broader markets during periods of declining benchmark. 

This factor is usually measured via the standard deviation in returns of stocks.

Combining the two factors would give investors the benefit of growth via the alpha factor and the advantage of stability through the low volatility factor.

By investing in a multi-factor scheme would mean that investors get exposure to multiple factors in a single product.

It would provide diversification as the cyclicality in one factor would be countered by the other factor.

Since investing is driven by a rule-based index, there is no scope for any bias. 

Taking the ETF route

The ETF invests in the underlying index – Nifty Alpha Low Volatility 30. The investment universe for constructing the index comprises the top 150 stocks from the Nifty pack (large and midcaps). 

From this set, stocks are filtered based on Jensen Alpha (for the past one year) and standard deviation (for the past one year). The top 30 stocks are selected based on equal weighted alpha and low volatility factors mentioned above and the index is thus constructed. It is rebalanced semi-annually. Individual stock weight is restricted to 5%.

One major advantage that the index has, especially in the current environment, is that it is dominated by large caps, with this segment accounting for nearly 85% of the stocks in the index. Large cap stocks are among the few pockets in the market where valuation comfort exists presently. It also lends stability to the portfolio and lowers risk levels.

Now, the Nifty Alpha Low Vol 30 TRI has outperformed the Nifty 100 TRI in 8 out of the past 10 financial years (FY15 to FY24).

This benchmark has also delivered more than indices such as the Nifty 100 TRI and Nifty 200 TRI.

Another key aspect of the alpha low volatility index is that it generates returns with relatively lower volatility compared to a few other benchmarks.

For investors, taking exposure to the Nifty Alpha Low Vol 30 ETF would make sense as it is a low-cost product. Since liquidity is reasonable, trading of the units in the indices would be comfortable. Investments can be done in small denominations and at periodic intervals.

(The author is ​​Principal- Investment Strategy, ICICI Prudential AMC)