Building a winning portfolio with multi factor strategies
"Compounding is the 8th wonder of the world" and we do hear about it more than enough in financial publications. But compounding your wealth consistently is the only answer if you want to realise your dreams of financial freedom.
How do you make a winning portfolio that can grow your wealth consistently and at low risk? We find the answer to this question in multi factor strategies. Let's dig into some financial data as we answer this.
Can passive investing lead you to financial freedom?
The answer is no. In the last decade, even with a couple of major bull markets, the large cap equity index would have given you a CAGR of less than 10%, bonds and gold would have given you a much lower return and mid caps would have given the highest 12% CAGR.
Will investing in specific sectors help?
FMCG, Financial Services & Banks have given almost 15% returns in the last decade but the single sector strategies are quite high risk and prone to drawdowns.
How do you reach the goal then?
We hear so many success stories from great small & medium cap stock pickers who pick up mutli-baggers. We know expert trend followers who ride the bull wave and deliver exemplary returns. We know proponents of quality stock picking who have delivered consistent compounding. There are many such themes or factors that out-perform passive strategies.
As a quant researcher, I look at these unique ways of investing as "factor based" investing strategies. Any portfolio's performance can be largely explained using well known themes. Any portfolio has its outperformance coming from one or more of these factors - growth, quality, value, momentum , low volatility, dividend yield, small cap premium etc.
This is not something that is unheard of. NSE publishes well known indices based on these themes since the last few years and they are increasingly gaining popularity in India.
How do various factors perform in India?
At Wright Research we do not use the NSE indices but create our own factor portfolios on these themes. So strictly based on our models (which have a proprietary element) the factor portfolios have given up to 20% returns in the last decade, with momentum, quality & low volatility factors leading the pack.
Do all factors perform well at all times?
No they do not. While there are times like the recent past when there is no stopping the momentum factor, we have seen times when the low volatility, dividend yield or even value factor has out performed the momentum factor.
So our answer to growing your wealth consistently year on year is to have a tactical combination of factors as your investing strategy. If you can define rules that help invest in the appropriate factor at the appropriate times you can reach your wealth goals!
Combining Multiple Factors
Markets and the economy go through phases. The business cycle, which reflects the fluctuations of activity in an economy, can be a critical determinant of equity sector performance over the intermediate term. The performance of economically sensitive assets such as stocks tends to be the strongest during the early phase of the business cycle when growth is rising at an accelerating rate, then moderates through the other phases until returns generally decline during a recession.
Just as we see cyclical and defensive sectors give performance sensitive to the business cycle, factor performances are also heavily dependent on market cycles. In an accelerating growth phase Momentum or Size factors outperform while in a slow growth phase quality stocks outperform. In a late phase of the cycle it might be prudent to focus on low volatility while in a recessionary phase asset allocation instead of factor allocation might come to the rescue!
Multi Factor Portfolios
At Wright Research, we research and forecast the business cycle and give the portfolio recommendation based on a tactical combination of factors. We rebalance our 20-25 stock portfolio monthly and keep our turnover low while being dynamic in our factor choices.
Our multi factor approach outperforms all single factor portfolios listed on the NSE
Our multi factor strategy has been running live for for almost two years. We have given a compounded annual growth rate of 41% during our time live at a risk of 13% and a drawdown of only 18% when the market went down almost 40%.
Our multi factor portfolio has been outperforming the index continually and consistently over the last 2 years. The latest performance numbers of our featured Momentum & Balanced Multi Factor Tactical stack like this:
Our performance is purely led by factor modelling and tactical factor selection using regime modelling. Our strategy is transparent, explainable and most importantly consistent. Factor investing is based on decades of research and has a very sound mathematical basis. We aim to use our focussed research to identify and utilise India specific factors that can deliver a diversified and consistent outperformance for our investors.