Significant Spike in Market Volatility – Is Quality the Factor to Play?

What’s the Point?

Indian equity markets have experienced significant volatility in recent weeks, due to a combination of potential reasons such as currency pressure, selling by Foreign Portfolio Investors (FPIs), tight domestic liquidity, and adverse global cues like weak global markets and lower potential for rate cuts in the US. During such times, a lens on factor investing suggests that quality investing tends to perform well. Higher quality companies are generally better poised to withstand financial and economic stress. Historical data shows that the quality factor tends to experience smaller drawdowns and recover faster during periods of significant market stress. In this context, investors could consider our New Fund Offer (NFO), HDFC Nifty 100 Quality 30 Index Fund, which aims to track the Nifty 100 Quality 30 Index. Staying invested through volatility has historically proven to be a sound investment strategy. India’s structurally robust economic growth, high forex reserves, and low corporate leverage should help in supporting market resilience.

Numbers in Perspective

Source: Bloomberg

What describes the current market fall?

The current market volatility can be attributed to a mix of factors:

• Adverse Global Cues: Weak global markets and lower potential for rate cuts in the US are contributing factors. Additionally, US markets have been negatively impacted by developments in the Artificial Intelligence space, with the ‘Magnificent 7’ stocks correcting significantly over the past few days.
• FPI Selling: One the biggest domestic reasons for market fall is significant FPI selling. While slower growth of overall economy, led by slower government spending in the first half of the year was known, additional pressure has come from the growing liquidity deficit and currency pressure. Cumulative FPI outflows since 17th December 2024 now exceed of Rs 1 Lakh crore, making this one of the most severe bouts of FPI selling in Indian capital market history. The market correction, in context of valuations being higher than historical averages, appears healthy.

Is the market stress structural?

While the above causes seem cyclical, bull market corrections can inflict significant stress before turning around. However, there are signs of improvement, with the RBI taking significant steps to improve domestic liquidity by injecting liquidity in the market via Open Market Operations (OMOs), Variable Rate Repo and Fx Swaps.

Historical performance of quality factor indicates a quality heavy portfolio could do well

In markets experiencing significant stress, Quality factor historically tends to perform better, capturing less of the market fall. In years where the market has been negative, the average performance of the Nifty100 Quality 30 TRI has been -5.8%, compared to Nifty 100 TRI at -10.3%. During past significant drawdowns, such as the taper tantrum and the Covid-19 pandemic, the quality index tended to fall less and recover faster than broad market indices.

Source: NSE Indices Ltd. Internal calculations. Data as of Dec 31, 2024. @Up (down) year is defined as a Financial Year where the Nifty 100 TRI gave a positive (negative) return. Simple average of FY returns for up and down years is calculated for both indices. Includes FY returns data from FY11-24. Note: The historical examples above are not exhaustive and are for illustration purposes. Past performance may or may not be sustained in the future and is not a guarantee of any future returns. HDFC AMC/Mutual Fund is not guaranteeing or promising or forecasting any returns.

Fundamental construct of a Quality portfolio could support better performance in market drawdown

Quality investing selects resilient, stable businesses with strong balance sheets which can offer relative stability during market stress (see image below). More resilient balance sheets (lower leverage) and higher quality of earnings (strong ROEs) aid in supporting the ability of businesses to withstand financial and economic stress.

Source: Metrics sourced from NSE Indices Ltd. index methodology. Data as of 31 December 2024.

Could Quality be the factor to play in current markets?

The current construct of the Quality portfolio has a higher weight in consumption, IT, and capital goods, which could hold it in good stead during the current market stress. Given its historical resilience during drawdown periods, investors might consider adding higher Quality to their portfolios via our NFO, HDFC Nifty100 Quality 30 Index Fund, that aims to track the Nifty100 Quality 30 Index. Refer the detailed presentation to know more!

Sources: Bloomberg, NSE Indices, RBI, and other publicly available information

About Tuesday’s Talking Points (TTP): TTP is an effort by HDFC AMC to guide key conversations in the Indian financial markets and investing ecosystem. We aspire to do this by providing relevant facts, along with our perspective on the issue at hand. If you have a topic that you would like to be featured here, please write to us at [email protected]

Disclaimer: Views expressed herein, involve known and unknown risks and uncertainties that could cause actual results, performance, or events to differ materially from those expressed or implied herein. Stocks/Sectors/Views referred are illustrative and should not be construed as an investment advice or a research report or a recommendation by HDFC Mutual Fund (“the Fund”) / HDFC Asset Management Company Limited (HDFC AMC) to buy or sell the stock or any other security. The Fund/ HDFC AMC is not indicating or guaranteeing returns on any investments. Past performance may or may not be sustained in the future and is not a guarantee of any future returns. Readers should seek professional advice before taking any investment related decisions.

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.

HDFC Nifty100 Quality 30 Index Fund (An open ended scheme replicating/tracking Nifty100 Quality 30 Index (TRI))