Factor-based investing has gained traction in India as investors seek systematic strategies to navigate different market cycles. It bridges the gap between passive and active investing, combining the best of both worlds. Unlike traditional investing, which may react to market fluctuations, factor-based investing provides a structured approach to identifying stocks with favorable characteristics. The AUM for factor funds in India has more than doubled in the past year, exceeding ₹40,000 crores by the end of 2024, compared to ₹14,000 crores a year ago.

Among various factor strategies,Quality Factor investingis often considered during periods when valuations are at their peak, growth opportunities become scarce, and investors seek stability by focusing on companies with strong fundamentals. During such periods, theQuality factorcan help investors manage uncertainty by providing a degree of resilience and stability in volatile market conditions. Its ability to balance stability and growth makes it a preferred strategy when market confidence is low.

What is the Quality Factor?The Quality Factor is an investment strategy that selects companies with strong financial fundamentals. It focuses on firms that have a proven track record of profitability, efficient capital utilization, and financial stability. These companies often exhibit lower volatility, making them well-suited for investors looking for consistency.

Key financial ratios used in Quality-based investing include:

-Return on Equity (ROE) – Measures how effectively a company generates profits from shareholders’ equity.

-Debt-to-Equity Ratio – Assesses financial leverage and a company’s ability to manage its debt responsibly.

-Earnings Stability – Evaluates the consistency of a company’s earnings over time.

-Accruals Ratio – Determines the quality of earnings by analyzing cash flow management.

By focusing on these factors, Quality investing ensures that companies selected for the portfolio have durable business models and are less prone to financial distress.

How Quality Factor Fared in One of India’s Longest Bull Runs (2020–2024)The BSE Quality Index delivered an annualized return of 22% over the past five years, outperforming its parent index, the BSE Large Midcap, by 4.01%. During 2020, when the market was on the path to recovery in the second half, Quality demonstrated strength, generating a 26% return.

Over the longer term, Quality has outperformed its parent index in 72% of the last 19 calendar years, reflecting its consistency. This indicates that Quality is not just another factor but can be a structured approach for seeking long-term outperformance.

How the Quality Factor Can Be a Reliable Choice Across Market Cycles
Companies with robust financial metrics are typically better equipped to navigate challenging economic conditions and recover quickly as the broader market stabilizes. During uncertain times or early recovery phases, investors often gravitate toward financially stable companies with proven track records. The Quality Factor is particularly effective in navigating downturns and market recoveries.

In bear markets, it experienced an average downturn of just -27%, slightly inferior to the Low Volatility factor, which, by its very nature, is designed to experience lower drawdowns. Interestingly, during the recovery phase, the Quality factor delivered a cumulative annual return of 41%, second only to the Value factor. This consistency may make it an intriguing choice for investors seeking balanced performance across market cycles.

Why Passive Quality Factor Investing Makes Sense

1. Removes Human Bias – Passive investing in the Quality factor relies on quantitative data, avoiding emotional decision-making.
2. Systematic & Transparent – A rules-based approach ensures that only financially strong companies are included.
3. Delivers Better Risk-Adjusted Returns – Quality investing provides stability, resilience, and sustainable long-term growth with lower costs.

For investors looking for a disciplined approach to equity investing, passive Quality Factor funds can be an efficient, low-cost alternative to active stock selection.

ConclusionQuality investing is a reliable strategy for navigating volatile markets, emphasizing companies with strong fundamentals, stable earnings, and efficient capital allocation. Given the current uncertainty in Indian and global markets, the Quality Factor offers investors a structured way to protect downside risks while capturing long-term growth opportunities.

As investment trends shift, focusing on financially strong and fundamentally sound companies can help investors weather economic downturns and participate in future market recoveries.

Pratik Oswal is Chief of Business Passive Funds at Motilal Oswal Asset Management Company