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Market volatility and economic uncertainty have dominated the last six months, triggering a sharp correction across equity markets. Amid these challenges, low volatility, factor-based mutual funds have demonstrated resilience, containing losses more effectively than both their parent index and other factor-based funds.
The Nifty100 Low Volatility 30 declined 15.1 per cent from its September 2024 peak, while its parent index Nifty 100 fell slightly more at 15.7 per cent. In contrast, other factor indices saw deeper cuts: Nifty200 Momentum 30 (-31 per cent), Nifty100 Alpha 30 (-26 per cent), Nifty Quality 30 (-19 per cent), and Nifty200 Value 30 (-16.5 per cent). Total return index (TRI) is considered.
Considering their strong performance in volatile markets, should investors allocate to low-volatility factor-based funds? These strategies effectively limit downside risk, but their performance lags during trending bull markets. Â We explore the fundamental characteristics of this strategy and compares it with other factor-based approaches.
Cyclical nature
Low volatility is one of several smart-beta investment strategies designed to outperform traditional market capitalisation-based indices in specific market conditions. Smart beta funds  passively track indices that are derived from conventional benchmarks using various fundamental, technical, and other filters applied by NSE and BSE. The  Nifty 100 Low Volatility 30 index represents 30 stocks from the Nifty 100 that have shown the lowest volatility over the past year.
Other widely used factors in smart beta investing include quality, value, momentum, and alpha. The performance of smart beta strategies tends to be cyclical—some periods see strong returns, while others bring underperformance. Low volatility tends to outperform during uncertain or turbulent markets. In contrast, value strategies often shine during recovery phases, quality performs well in volatile or bear markets, and momentum tends to lead in strongly trending bull markets.
Low volatility portfolios are constructed based on price performance, specifically by evaluating the standard deviation of daily price returns over the last one year. Currently, 11 mutual fund schemes  employ the low volatility strategy. Of these, nine track the Nifty 100 Low Volatility 30 index, selecting low-volatility stocks from the Nifty 100 universe. The remaining two follow the BSE Low Volatility index, which selects 30 low-volatility stocks from a broader pool of 250 large and midcap companies. Additionally, five mutual fund schemes incorporate low volatility as part of a multi-factor approach.
Defensive portfolio
Low volatility portfolios generally include companies with stable businesses. Â These portfolios tend to steer clear of highly cyclical or speculative stocks, instead leaning toward defensive sectors such as consumer staples, utilities, and healthcare. Over the last five years, the top sectors (as classified by ACEMF database) that were part of the Nifty 100 Low Volatility 30 index are IT (an average weight of 14.5 per cent), pharma (10 per cent), banks (8 per cent), food products (8 per cent) diversified FMCG (7.4 per cent) and automobiles (7.2 per cent).
These portfolios typically avoid sectors prone to volatile earnings and stock prices, such as commodities, real estate, capital goods, and cyclical consumer discretionary segments like luxury goods. Among the top stocks that have consistently featured in the index with significant allocations are Nestle India, Hindustan Unilever, Britannia Industries, Tata Consultancy Services, and ITC.
Performance in various cycles
The low volatility strategy exhibits distinct performance behaviour depending on market conditions. It tends to perform well in rangebound markets. But its true strength becomes apparent during market corrections and bear phases, where it typically experiences smaller declines than the overall market, leading to notable relative outperformance. The accompanying table shows that during downturns such as those from March 2015 to February 2016, January 2020 to March 2020, October 2021 to March 2023, and the ongoing phase, the low volatility index has effectively cushioned losses.
However, this strategy tends to lag during strong bull runs, largely because it avoids high-beta stocks. Â Such underperformance is a known trade-off for the protection it offers in downturns. Low volatility strategies generally trail the broader market during phases marked by high risk appetite, economic rebounds that favour cyclical stocks, and sector rotations toward growth and momentum themes.
Should you invest?
The inherently defensive nature of low volatility funds may result in slower portfolio growth over time. Limited exposure to mid-cap and avoidance of small-cap stocks can restrict further upside potential especially when compared to other factor-based strategies. However, the strategy’s ability to minimize drawdowns positions these funds to deliver more balanced returns and potentially stronger long-term outperformance. The accompanying rolling return chart shows that the low volatility funds can generate steady, moderate returns over longer horizons, such as 10 years or more. It posted a 15 per cent annualized return based on a 10-year rolling analysis over the past 15 years.
For investors who prioritize stability and lower risk, especially during uncertain market periods, these funds offer a compelling option.
Multi-factor funds that incorporate low volatility into their approach may present an even better alternative. By blending multiple factors, they reduce dependency on a single strategy and are better equipped to perform consistently across varying market cycles. At present, five such schemes combining alpha and low volatility are available. A portfolio allocation of around 15–20 per cent to these strategies could be a well-balanced choice for investors with moderate risk profile.
Published on April 12, 2025
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