The market fall in October 2024, following a long rally, was difficult to comprehend, with the Nifty 500 experiencing a decline of 6.4%. Various factors contributed to this downturn, including FII selling, muted corporate earnings, and the conflict in the Middle East. Investors are now closely monitoring global developments and their potential impact on the Indian economy.
Low Volatility strategy
Factor funds often come into the limelight, particularly the Low Volatility Index, during these uncertain times. The Low Volatility Index is designed to invest in companies with lower price fluctuations and stable earnings, typically focusing on mature companies.
Motilal Oswal AMC provides investors with the necessary exposure to the Low Volatility factor through its Motilal Oswal BSE Low Volatility Index Fund. This Index is managed by Swapnil Mayekar, Rakesh Shetty and Dishant Mehta. See other funds managed by these Fund Managers.
One significant benefit of the Low Volatility strategy is its ability to reduce overall portfolio risk while providing more consistent returns, making it an attractive option for risk-averse investors seeking stability in turbulent markets.
Historical Performance of BSE Low Volatility Index Vis-à-vis Nifty 500 (herewith referred to as “markets”)
Sector Composition
The Low Volatility Index primarily includes consumer-focused sectors, which are recognized for their consistent stability and resilience, especially in volatile markets. As of October 2024, the FMCG and consumer discretionary sectors together account for 43% of the total index, reflecting the ongoing demand for essential goods and services, even during economic downturns. Healthcare, considered a defensive sector, holds a 14% weight in the index. Large banks, which are known for their relatively low stock price fluctuations compared to other sectors, contribute 20% to the index, further adding to its stability.
Present Dilemma
One interesting observation that has been noticed in October 2024 is that the Low Volatility Index fell more than the broad-based index. The BSE Low Volatility Index dropped by 8.2%, while the Nifty 500, typically more volatile due to its inclusion of small-cap stocks, decreased just by 6.4%.
Low Volatility Index: Shock Absorber or NOT?
This directly contradicts the idea of investing in the Low Volatility Index because of its supposed lower risk. It directly raises the question of whether it is still safe for a risk-averse investor to invest in this popular factor index during periods of higher volatility. To understand the reasons for this rapid decline, a closer analysis of the Low Volatility Index’s performance is needed.
Size Factor
The BSE Low Volatility Index is predominantly composed of large-cap companies, with nearly 80% of its constituents falling into this category. This focus on large-cap stocks is significant, especially considering that during the October month, the Large Cap companies experienced a decline of 6.8% that was more pronounced than that observed in mid-cap and small-cap indices which was 6.4% and 3.6% respectively. It was observed Even with strong domestic inflows, the market tends to drop when FPIs sell, due to their significant ownership in the free-float market capitalization. FPIs currently hold approximately 40% of the free-float market cap in Nifty 50 stocks, making large-caps particularly sensitive to their actions. FIIs sold a net of Rs 114,445.9 crore in October 2024. It is the highest selling number by FIIs in a month.
Sector Attribution
As mentioned, the Fast-Moving Consumer Goods (FMCG) and Consumer Discretionary sectors together account for 43% of the BSE Low Volatility Index Fund. During October 2024, the FMCG sector experienced a decline of 9.6%, marking its largest monthly drop in the past six years. This was followed by the Consumer Durables sector, which fell by 10.2%.
The decline was primarily driven by a slowdown in sales in urban India, rising commodity prices, and weak quarterly results. For context, food inflation surged to 9.2% in September, up from 5.4% in July, its highest level in 13 months.
The consumer segments alone contributed 60% of the negative returns for the Low Volatility Index in October. This raises the question: can we now say that consumer sectors, traditionally known for their stability, are more volatile than before? Nevertheless, the rebalancing effect of the Low Volatility Index will exclude constituents with higher fluctuations, ultimately ensuring a more balanced performance.
Low Volatility Index: Shock Absorber or NOT?
Although the underperformance of the Low Vol Index than the markets appear to be largely short-term in nature, it is crucial to examine whether similar occurrences have taken place in the past, where the Low Volatility Index experienced greater declines than the broader indices. Upon review, it has been observed that over the past 75 quarters, there were only 7 instances in which the declines in the Low Volatility Index exceeded those in the market, meaning that approximately 90% of the time, the Low Volatility Index has outperformed the market by greater margins. This suggests that such occurrences are relatively rare and may be considered exceptional within the broader historical context.
Enhanced risk-adjusted performance with the Low Volatility Index
The above metric provides compelling evidence that the risk-adjusted returns of the Low Volatility Index consistently surpass those of the broad-based Index. The 15-year risk adjusted return for Low Vol Index is 1.6 times of the broader market depicting better performance in the long run. This trend highlights the effectiveness of low volatility strategies in providing not only a safer investment option but also one that yields more favourable returns over time, making it an better choice for risk-conscious investors seeking to enhance their portfolios.
Conclusion
Investing in the Low Volatility Index may be prudent choice due to several key benefits. Over the long term, it may offer more consistent returns with fewer fluctuations compared to broader indices, making it potentially suitable to risk-averse investors. While it may experience short-term volatility, the Low Volatility Index historically demonstrates smaller drawdowns during market downturns, helping to mitigate large losses. Its periodic rebalancing further reduces risk by excluding higher-volatility stocks, and it serves as a valuable diversification tool for portfolios with higher exposure to more volatile assets. For conservative investors, the Low Volatility Index provides an equity investment option with lower risk, offering a balance between stability and potential returns.
Low Volatility Index: Shock Absorber or NOT?
Product Labelling
Motilal Oswal BSE Low Volatility Index Fund
Risks Associated with scheme:
a. Motilal Oswal BSE Low Volatility Index Fund is passively a managed index fund i.e. the amount collected under the scheme is invested in securities of companies comprising the underlying index in the same weightages as they have in the underlying index.
b. The composition of the underlying index is subject to changes that may be affected periodically by
the Index Service Provider.
c. Performance of the underlying index will have a direct bearing on the performance of the scheme.
d. The extent of the Tracking error may have an impact on the performance of the scheme.
Disclaimer: This article has been issued on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The Stocks mentioned herein is for explaining the concept and shall not be construed as an investment advice to any party. The information / data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. All opinions, figures, estimates and data included in this article are as on date. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Readers shall be fully responsible/liable for any decision taken on the basis of this article.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
