In the last two editions of the Nippon Way, we explained to you the importance of having Sector Limits and Active Share thresholds possibly to achieve relatively consistent returns. In Part 3 of the Nippon Way, we are bringing to you the concept of ‘Style Diversification’ and its relevance in portfolio construction.
Different Factors or ‘Styles’ would work at various points in time in the market. For example, there may be times when ‘Growth’ style of investing may be in favor. There may be other times where ‘Value’ investing may be a popular theme, which may be working in the market. Similarly, within the equity markets, there have been times when large caps fare relatively better than the broader markets – mid cap and small caps, and vice versa.
If the Fund Manager is spot on, and rides the bandwagon by being in the right ‘styles’ ahead of the markets, he may create reasonable alpha. On the other hand, if the Manager may get it wrong, the portfolio returns may suffer. Factor contributions tend to rotate – a particular factor working well at sometimes, may get replaced by another – both in the short term and long term. It would be difficult for a Fund Manager to get the trends right all the time, or even most of the times.
Hence, a prudent approach may be to strike a balance in Factor or Style exposures.
Morgan Stanley Capital International (MSCI), a global leader in providing tools to help clients build and manage better portfolios, implement strategies and measure performance invented a common language to explain risk and return through the lens of factors. MSCI has developed Factor Models in consultation with the world’s largest investors and has research backed by four decades of factor data. MSCI, through their tool MSCI Barra, provides stock-level factor exposure details on different parameters for the Indian markets, on factors / styles such as Growth, Momentum, Size, Profitability, Leverage, etc.
At Nippon India Mutual Fund, we have opted for having balanced factor / style exposure for the diversified equity funds. We check for the factor exposures of funds on a monthly basis in our PDCA meetings (acronym for Plan, Do, Check and Act – a formal review mechanism to evaluate the portfolios in detail), through data from MSCI Barra. Any excessive tilts on any factor is encouraged to be corrected by carrying out necessary changes to the portfolio.
By doing so, extreme exposures, and consequently volatile fund performance may be avoided. Risk mitigationby striking the right balance, the Nippon Way!
Disclaimer: Past Performance may or may not be sustained in the future. The information herein above is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations oras a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their associates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document.