How to Build a Mutual Fund Portfolio Using Factor Investing

For decades, investors followed traditional Investing styles: active vs passive, equity vs debt, large-cap vs mid-cap. But now, a data-driven strategy is making waves in India — Factor Investing. Globally used by institutional investors and hedge fund, factor investing targets specific characteristics or ‘factors’ that drive returns. It brings structure, transparency, and consistency to mutual fund selection — especially in an unpredictable Market.

Whether you're a new-age DIY investor or building a core Portfolio for long-term goals, factor investing can give you an edge.

What is Factor Investing?

Factor investing is a strategy where you choose investments based on certain characteristics (factors) that are historically proven to deliver better risk-adjusted returns.

There are two types of factors:

• Macro Factors – Economic Growth, Inflation, interest rates

• Style Factors – Value, Momentum, Quality, Low Volatility, Size

Mutual fund investors can now access these factors through factor-based or "Smart Beta" funds.

Key Factors Explained (With Examples)

1. Value

Investing in stocks that are undervalued compared to their fundamentals (low P/E, P/B ratios).

Example Fund: ICICI Prudential Nifty50 Value 20 Index Fund

2. Momentum

Investing in stocks that have shown strong recent performance.

Example Fund: UTI Nifty200 Momentum 30 Index Fund

3. Quality

Focusing on companies with strong balance sheets, high ROE, low debt.

Example Fund: DSP Nifty 100 Quality 30 Index Fund

4. Low Volatility

Preferring stocks with stable price movements.

Example Fund: ICICI Prudential Nifty Low Vol 30 ETF

5. Size (Small-Cap Tilt)

Targeting small-cap or mid-cap exposure for higher growth potential.

Often captured in small-cap Mutual Funds, but can also be part of smart-beta blends.

Why Use Factor Investing in Mutual Funds?

• Reduces behavioural bias
• Offers diversification beyond sectors or market caps
• Enhances long-term performance consistency
• Transparent, rules-based selection
• Helps avoid fund manager underperformance

🧩 How to Build Your Mutual Fund Portfolio with Factors

Step 1: Identify Your Goal and Risk Appetite

• Long-term wealth creation → blend of value + quality
• Short-term growth → momentum with caution
• Stability-focused → low-volatility + quality

Step 2: Choose 2–3 Core Factors Based on Your Style

• Conservative investor? Go with quality + low volatility
• Aggressive? Try momentum + value

Step 3: Pick Index Funds or Smart Beta Funds Matching These Factors

• Use direct plans with low TER for better compounding.

Step 4: Diversify Across Factors, Not Just Funds

• Avoid overloading on one style. Combine different factors to Handle market cycles.

Step 5: Rebalance Annually

• Factor returns rotate. What works in 2023 may Underperform in 2025. Rebalancing keeps the mix effective.

Sample Factor-Based Portfolio (Moderate Risk)

Note: Adjust weights as per risk profile. All funds should be direct plans.

Things to Keep in Mind

• Factor funds may underperform in certain market phases.
• Smart Beta ≠ Guaranteed returns. It’s still equity investing.
• Check fund history, tracking error, expense ratio.
• Don’t combine too many overlapping factors.

FAQs

Q1. Is factor investing suitable for beginners in India?

A: Yes, especially through mutual funds and index-based smart beta strategies, beginners can access factor investing with lower complexity.

Q2. Can I use SIPs in factor-based funds?

A: Absolutely. Most factor funds accept SIPs, allowing you to build long-term exposure in a disciplined manner.

Q3. What’s the difference between factor funds and traditional mutual funds?

A: Factor funds follow rules-based, quantitative models, whereas traditional active funds depend on fund managers’ stock-picking skills.

Final Thoughts

Factor investing gives mutual fund investors a data-backed, structured way to build portfolios without chasing hot funds or depending too much on fund managers. As India’s mutual fund Industry evolves, adopting factor strategies early can give retail investors a smart edge. Start slow. Stay consistent. And let the factors do their work.