Alpha investing is about buying current winners, i.e., stocks that have done well in the recent past, from a stock performance point of view. Alpha investing is about catching the latest trends, which means it seeks to capture stocks, sectors, and market cap segments that are getting traction from the market.
MSCI research shows, on a historical basis, that the alpha factor has been one of the strongest generators of excess returns and has typically outperformed in a macroenvironment characterised by a long cycle in underlying market trends (i.e., a long cycle of bull runs or long cycle of bear runs).
Research shows that stocks that have recently risen or fallen in price will continue that trend over the short-to-medium term, typically over six to 12 months. And over the long term, stocks with a high alpha score will outperform the market.
NSE Indices has developed the “Nifty200 Alpha 30 Index", which aims to track the performance of the top 30 companies within the Nifty 200 Index selected based on their Alpha score. The Alpha score is the outperformance the stock has generated in the last 1 year, over and above what has been suggested by the Capital Asset Pricing Model (CAPM).
The index gives true to the label representation of capturing a trending market and will give the highest weightage to stocks that have done well irrespective of their market cap, in turn making the index unbiased towards large-cap or mid-caps, and whichever segment is outperforming will get higher allocations.
With index rebalancing taking place every 3 months, the index adapts to changing market conditions, and increases the weight to current outperforming stocks/sectors relative to the market, and adapts itself as the market outperformers change.
For instance, the index was overweight on the healthcare sector, which witnessed an uptrend during COVID-19 and currently the index is overweight on the capital goods sector, which saw its underlying stocks touching all-time highs in this bull run.
As market trends change, the market cap allocation changes as intended by alpha investing. In 2018-19, large caps were doing well relative to midcap, so the portfolio was tilted towards large cap. Similarly, in 2023, the midcap segment witnessed a huge rally, and the portfolio was tilted towards the midcap segment. After a strong-run in midcap in the past one year, the index is now favouring the large cap segment due to a tilt towards Nifty Next 50 stocks, which have done well recently.
This dynamic allocation to evolving market conditions has resulted in the outperformance of the Nifty 200 Alpha 30 Index compared to other broad-market and smart beta indices over different time horizons. Over the past 10 years, the Nifty 200 Alpha 30 Index has generated a return of 24.8% vs. 14.6% of the Nifty 200 Index, which is an outperformance of 10.2% over its parent index.
Source: NSE Indices Limited, data as on June 28, 2024; Past performance may or may not sustain in future. The index return is in Total Return Variant.
But investors should understand that Alpha investing is a high-risk, high-reward strategy. It has higher volatility and higher drawdowns compared to broad market indices. The 5 year volatility of the Nifty 200 Alpha 30 is 23.1%, which is around 4.3% more than the underlying Nifty 200 Index. Investors who have a higher risk appetite and the cushion to absorb higher drawdowns should only explore these strategies.
In a growing market like India, the Alpha strategy has done well historically in the long term, especially in bull markets. If we look from a long-term point of view, in the next 10 years, as India continues to ride its growth story, there may be higher chances of a period with good market performance, and the alpha factor may serve as a good strategy to capture this trend.
Investors may seek to invest in this product if they want to capture alpha strategy after assessing their risk profile and invest in funds based on these indices with a long-term intent in the current market scenario.
Siddharth Srivastava, Head – ETF Product & Fund Manager, Mirae Asset Investment Managers (India)