Should you diversify your portfolio by adding mutual funds focused on quality strategy?

Should those looking at diversifying their portfolios with a different investment style consider the quality theme now?

Past performance

With the markets going through a phase of uncertainty, past performance suggests that the quality theme tends to do well during such times.

In 2013, when the US Federal Reserve started to unwind the huge liquidity surplus it had maintained to stimulate the economy, the benchmark Nifty 50 Index gained 6%, while the Nifty 200 Quality 30 Index advanced 17%. It outperformed other strategies — with the Nifty 200 Value 30 Index losing 15%, the Nifty 200 Alpha 30 Index adding 14% and the Nifty 200 Momentum 30 Index rising 10%.

Value strategy focuses on stocks trading at cheaper valuations than their earnings and intrinsic value. The alpha strategy calls for investing in stocks that have widely outperformed market benchmarks in recent periods, and the momentum strategy looks for stocks with recent price up-moves.

In 2018, when the markets faced pressure from the impact of the IL&FS crisis, the Nifty 50 Index was up 4%, while most other strategies yielded negative returns. However, the Nifty 200 Quality 30 Index delivered 7% returns.

“In today’s environment of economic uncertainty and moderating growth, businesses with sound financials and sustainable profitability stand out,” said S Naren, executive director and chief investment officer of ICICI Mutual Fund, which recently launched the ICICI Prudential Quality Fund. “A quality strategy-oriented fund aims to tap into this potential by selecting high quality companies available at reasonable valuations, thereby aiming to build a resilient portfolio designed to perform across market cycles. With attractive valuations in the quality segment, we believe this is an opportune time for investors to adopt a quality-focused strategy.”

While most funds in this segment are passively managed – tracking the performance of the quality index – ICICI MF’s quality fund is an actively managed fund. Experts expect quality as a theme to do well going ahead, as it has underperformed other strategies from FY21 to FY24.

“The volatility induced in the market over the last few months (GDP slowdown, tariffonomics, Indo-Pak situation) has poked the bubble of a pure liquidity and deep value driven rally in stocks and sectors,” said Sunil Subramaniam, a market expert and former mutual fund CEO. “So now companies with sound financials, deep moats and entry barriers, high corporate governance and relative stability and predictability of earnings are the ones which will withstand the test of facing up to the uncertain local and global environment over the next few months. In effect, it’s the time for ‘quality’ to dominate allocations by both foreign institutional investors and domestic institutional investors.”

Should you go for it?

Strategy-based investing can be considered more of a tactical allocation than part of one’s long-term core portfolio. Investors can complement the quality strategy with other strategies.

“By itself, quality may not always work but combining it with momentum can give a better investor experience,” pointed out Kavitha Menon, founder of Probitus Wealth.

Quality can also be combined with value because when value does well, quality underperforms and vice-versa. However, investors who are at the beginning of their investment journey should stick to regular diversified equity funds to build up their core investment portfolio before looking at tactical investment calls.