Motilal Oswal Hedged Equity Multifactor Strategy

The Motilal Oswal Hedged Equity Multifactor Strategy AIF was introduced on March 8, 2022, according to Motilal Oswal Asset Management Company (MOAMC). The latest offering from Motilal AMC is an open-ended quantitative equity fund in the Category III AIF market. The company is well known for introducing a variety of passive funds.

A first-of-its-kind strategy, the Motilal Oswal Hedged Equity Multifactor AIF blends tail-hedging with a multifactor, model-driven investment methodology. This strategy’s little overlap with Nifty50 businesses and correlation of around 65-70% results in a distinct portfolio exposure.

With regard to stock selection and weighting, the Equity portfolio is entirely automated. The equity approach builds a focused portfolio of 20–25 equity equities using investment criteria such as quality, low volatility, value, and momentum.

The goal of tail-hedging is to shield the investor from black swan occurrences, which are unexpected yet have historically contributed significantly to portfolio losses. By establishing a low-cost “longvolatility” position that gains when market volatility increases during certain times, the fund aims to offer this protection.

Starting in 2011, the back-tested returns of the strategy were able to continuously produce greater returns at lower volatility than the scheme’s benchmark, the NIFTY 500 TRI, over a period of ten years.

The fund’s diversified portfolio, which has less BFSI exposure and little overlap with the NIFTY 50 index, results in a significantly lower correlation with the NIFTY 50 index. The portfolio is built on a methodology that blends elements like quality and low volatility, which historically have produced alpha in down markets, with elements like value and momentum, which historically have performed well in up markets. The addition of tail hedging offers portfolio protection from significant losses as well as funds for market downturn investments.

The year 2022 has been challenging for equities investors all across the world thus far. By the end of June, 19 of the 47 nations that MSCI had categorized as developed or developing had seen declines of at least 10%, and up to 37 nations had experienced negative returns for the year. Closer to home, the NIFTY500 TRI had dropped almost 18% from its last top and was on the verge of crossing the psychological threshold of a -20% decline.

To make matters worse, US inflation for June was higher than expected at 9.1% year over year, the largest increase since 1981. However, if someone had interpreted that as a signal to reduce their equity exposure in anticipation of greater drawdowns, they could have missed out on a remarkable (rebound?) bounce in July. In July 2022, 45 of the nations out of 47 produced positive returns, with 21 seeing increases of more than 5%. In terms of monthly returns for the index since 1998, the NIFTY500 TRI returned 9.7% for the month, placing it in the 10th percentile.

The multifactor AIF produced -2.5% for the three months that ended in July 2022 compared to 0.2% for NIFTY500 TRI (post fees, before taxes)1. The fund has earned -3.4% since its inception2 compared to the benchmarks -0.7%. Automobiles and capital goods were the two industries that contributed most to the returns during the previous three months and overall since they started. The choices they made regarding allocation and selection produced alpha in these areas. Consumer durables have trailed the most since their beginning, while financial services have lagged the most over the past three months. Additionally, the portfolio had a very small allocation to the utilities and power sectors, which were major drivers of benchmark gains.

If you were a factor investor, the scenario would be much crazier. Value has performed the best in India so far this year. The value last fared better than all other factors in 2016, after which it experienced several particularly severe drawdowns that prompted most participants to write obituaries for the factor. It is accompanied by the low volatility component, which had a stunning turnaround, going from one of the worst performers when they produced The most recent quarterly investor letter to the greatest performer during the next three months.

Again reversing the pattern from the first four months of 2022, low profitability junk companies also declined more than highly profitable equities. The momentum component had the opposite trend, going from one of the greatest performers up until April to the poorest performer during the next three months. Companies with the lowest momentum outperformed those with the highest momentum, signalling a change in the status quo. This was especially evident in the sectoral shifts away from IT and toward auto during quarterly rebalancings in the momentum portfolios.

On a quarterly or perhaps even annual time frame, it is evident that components can evolve in radically different ways, frequently making short-term trends unimportant. However, factors have also proven to be capable of outperforming over the long run. Thus, the intriguing topic of how long it is long-term arises. They utilize US market data that spans 60 years because there isn’t much data available in the Indian market. They emphasize the likelihood of each component producing an outperformance over the benchmark for various holding durations in Table 2. Even during 10-year holding periods, components tend to underperform individually. But if they use a multi-factor strategy by diversifying across components, the chances dramatically increase.

The low Volatility Factor is frequently promoted as a protective investment. However, the factor underperformed the market in the year’s first half since it did not perform as predicted, even though high volatility stocks outperformed. This led them to examine how low volatility performed during previous instances of market decline. They discovered something intriguing: when the market downturn grew more severe, factor performance actually improved.

Initial levels of drawdown (10 to 20% decline in a quarter) did not seem to be much improved by low volatility compared to the broader market. But the low volatility component gradually began to outperform more severe market declines, declining much more slowly than the market. As market sentiment deteriorates, this is compatible with human behaviour of “flight to safety”. Although it started off slowly during the opening legs of the fall, it was encouraging to see the low volatility component perform similarly throughout the most recent decline. Perhaps it is still in good shape.