Indian and global markets have been experiencing high volatility over the past few months, making many new investors jittery. In a conversation with Business Today, Vivek Sharma, Investment Head at Estee Advisors, shares his insights on factor-based investing, the impact of global macroeconomic trends, and the evolving landscape of active and passive strategies.
He discusses the advantages of quantitative investing, common pitfalls retail investors should avoid, and the role of macroeconomic indicators in investment decisions. With a focus on systematic, data-driven strategies, Sharma offers valuable perspectives on navigating today’s dynamic financial markets.
Q. You have extensive experience in trading international markets. How do global macroeconomic trends influence your investment strategies in India?
In today’s increasingly interconnected world, global economies are no longer confined within their own borders. This interconnectedness is evident as we witness the impact of foreign institutional investors (FIIs) withdrawing nearly 5 lakh crores from the Indian markets in the recent past due to global factors.
We focus on adapting to these global macroeconomic trends rather than trying to predict them. This adaptive approach allows us to remain flexible and responsive to the ever-changing market conditions, which is essential given the inherent volatility and unpredictability of global markets.
Our investment strategies are deeply rooted in data-driven methodologies which enable us to process vast amounts of data efficiently and identify and adapt to emerging trends, whether they arise from geopolitical events, economic policies, or shifts in market sentiment.
Q. Which sectors do you see as the biggest investment opportunities in the next 3–5 years, and why?
We employ a sector-agnostic quantitative approach to investing. Rather than attempting to predict which sectors will perform well, we utilise a sector block strategy where the investment universe is evaluated based on sector-specific factors. Typically, this block carries a weight of 20%, although this can vary depending on the prevailing market conditions.
Predicting future sector performance is inherently challenging, which is why we prioritise maintaining a well-diversified portfolio across various sectors. Our monthly portfolio rebalancing process enables us to adapt to changing market environments and adjust our exposure dynamically.
While sectors or themes like Green Energy or the India Consumption Fund may seem appealing, they often cloud judgment. Historical data indicates that sector performance is highly cyclical. Therefore, our sector-agnostic and quantitative approach allows us to invest in an objective and rational manner.
Q. How should retail investors adjust their portfolios in response to the latest Budget announcements?
If you have to adjust your portfolio after every market event, you have the wrong portfolio.
Numerous studies have shown that a more passive and laidback approach to investing often yields better long-term wealth than making frequent adjustments based on news or market movements. My recommendation is to stay invested and hold on to your portfolio without constant intervention.
Q. What are the biggest mistakes retail investors make when adopting quantitative strategies, and how can they avoid them?
Retail investors using quantitative strategies face several challenges. Over relying on single factors, like past performance, can lead to poor decisions. A lack of intuitive reasoning may result in misleading conclusions. Biases in back testing, such as survivorship and look-ahead biases, can distort results.
Overfitting models to historical data reduces real-world effectiveness. Retail investors might create overly complex models that fit historical data perfectly but fail in live markets. This is known as overfitting. To prevent this, investors should aim for simpler models that generalise well across different market conditions.
Lastly, even with quantitative strategies, retail investors can fall prey to emotional biases like fear and greed, leading to poor decision-making. It’s essential to follow quant strategies with discipline, sticking to predefined rules and avoiding emotional reactions to market fluctuations.
Q. What key macroeconomic indicators should investors track to make informed investment decisions in the current environment?
Macroeconomic indicators can offer valuable insights, we track about 18 macro factors, and however they often lag and may not be highly useful for retail investors making immediate investment decisions. Economic data tends to be volatile in the short run but remains quite stable over the long run. Many renowned investors, including Howard Marks and Warren Buffett, typically assume a static macro environment when evaluating the market. Our focus should lean more toward company fundamentals and long-term value rather than short-term economic fluctuations.
Q. Can you explain how factor-based investing differs from traditional discretionary investing, and what advantages it offers?
Factor-based investing and traditional discretionary investing are two distinct approaches to managing investment portfolios, each with its own methodology and advantages.
Factor-based investment approach is quantitative and systematic, relying on historical data to identify factors that drive asset returns. Factors are specific characteristics of stocks, such as momentum or value that influence performance. For example, the momentum factor suggests that stocks with recent price increases are likely to continue performing well.
Factor-based investment involves constructing portfolios by selecting stocks based on these factors. This method is data-driven, allowing for quick decision-making. It offers transparency, as the factors influencing performance are clearly defined. Additionally, it can provide diversification benefits by combining multiple factors, potentially leading to better risk-adjusted returns.
In contrast, traditional discretionary investment approach relies on the expertise and judgment of fund managers, who conduct research and evaluate companies. This method is more subjective and depends on the manager’s insights. While it allows for flexibility, it can be time-consuming and may lack the systematic rigor of factor-based investing.
One key advantage of a factor-based investment approach is its ability to process vast amounts of data quickly, enabling timely portfolio adjustments. It reduces human biases and emotions, providing a more objective approach. The diversification achieved through multi-factor models can lead to lower volatility and potentially higher returns compared to traditional methods.
Q. There’s an increasing shift towards passive investing. Do you believe active quant strategies can consistently outperform index funds in the long run?
Data from SPIVA reports makes a strong case for passive management. As per the report, 70 to 80% of fund managers are not able to beat their passive buy-and-hold benchmark index. This has led to a massive migration of investors from active to passive strategies, especially in developed markets like the US.
However, passive investing works only because of active investing. A passive fund manager competes on the lowest expense ratio with other fund managers and thus spends no time analysing corporate governance practices or participating in the decision-making of companies. Active fund managers, through their research, also help in resource allocation.
So, while passive investing has gained popularity, it cannot fully replace active investing – they must coexist. What the right level of passive vs. active investing should be in the overall market is hard to tell. However, in developing markets like India, there are ample opportunities for well-designed strategies to produce consistent outperformance.