Factor investing has revolutionized systematic equity management globally. The challenge in India is adapting factor definitions and construction methodologies that were developed primarily for US markets to the unique characteristics of Indian equities—different accounting standards, ownership structures, and market microstructure.
Value Factor in India
The traditional price-to-book ratio works differently in India due to revaluation practices and the prevalence of promoter-held companies. We've found that enterprise value to EBITDA (EV/EBITDA) combined with price-to-earnings provides a more robust value signal. Additionally, adjusting for cash holdings is crucial given that many Indian companies hold significant cash balances.
Momentum Considerations
Momentum works in India, but with important nuances:
- 12-1 month momentum (skipping the most recent month) shows strong performance
- Liquidity adjustment is critical—many momentum stocks in small-caps are illiquid
- Sector-neutral momentum reduces the "hot sector" risk
- Combining with volatility adjustment improves Sharpe ratio
Quality Factor
Quality investing focuses on companies with sustainable competitive advantages. In the Indian context, we emphasize:
- Return on Equity (ROE) with adjustments for exceptional items
- Earnings stability measured by coefficient of variation
- Balance sheet strength—D/E ratio and interest coverage
- Promoter holding and pledging as governance indicators
Portfolio Construction
The final step is combining factors into a portfolio. We use a composite score approach with dynamic factor weights based on current valuations of each factor. Optimization is performed with transaction cost penalties to avoid excessive turnover.
The most important insight from factor investing is that returns come from bearing systematic risks. Understanding which risks you're compensated for is the foundation of intelligent portfolio construction.