Earlier this year, I was captivated by the intriguing concept of factor-based investing. Factors such as size (SMB), momentum, market risk (MKT), quality, and value can significantly account for asset performance. In India, however, options for such exposure are limited. After research, I selected a few funds—Nifty 50 Equal Weight, Nifty 200 Low Volatility, Nifty 50, and Nifty Next 50. For international diversification, I included the Nasdaq 100. I wished to included Nifty 200 Momentum 30 but there weren’t enough data points available.
Data Gathering:
To adhere to factor-based investing principles, I collected comprehensive data for these selected funds, extending back to mid-2018. My main objective was to construct an optimal portfolio that maximizes the Sharpe Ratio.
Analysis and Results:
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Sharpe Ratios of Individual Funds (in %):
- Close_Nifty_50_Equal_Weight: 3.27%
- Close_Nifty_50: 2.78%
- Close_Nifty_Next_50: 2.24%
- Close_Nifty_200_Low_Vol: 2.34%
- Nasdaq iShares Close: 2.91%
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Standard Deviations of Individual Funds’ Returns (in %):
- Close_Nifty_50_Equal_Weight: 1.22%
- Close_Nifty_50: 1.23%
- Close_Nifty_Next_50: 1.22%
- Close_Nifty_200_Low_Vol: 1.01%
- Nasdaq iShares Close: 1.49%
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Optimal Portfolio Weights:
- Close_Nifty_50_Equal_Weight: 34.83%
- Close_Nifty_50: 0.40%
- Close_Nifty_Next_50: 0.15%
- Close_Nifty_200_Low_Vol: 32.27%
- Nasdaq iShares Close: 32.34%
- Optimal Portfolio Sharpe Ratio (in %): 63.3%
Discrepancy in Results:
Interestingly, the Sharpe Ratios I calculated are significantly higher than those reported on Value Research for the corresponding funds. This discrepancy could be due to different methodologies or data ranges. Importantly, a 7% risk-free rate was used, reflecting the current short-term bond yields in India.
Highlight:
The Sharpe Ratio of the optimal portfolio stands out significantly at 63.3%, indicating a potentially better risk-adjusted return compared to the individual funds. This increase in sharpe seems too good to be true, but the methodology checked out.
Conclusion and Invitation for Feedback:
While there’s a notable difference between the calculated and published Sharpe Ratios, the portfolio weights and the methodology are transparent. I welcome criticisms and thoughts from all quarters. Is this a viable approach to factor-based investing in India? Your insights are highly appreciated.