While passively managed index funds and ETFs tracking factor-based indices have gained a notable traction in the Indian mutual fund industry, fund houses are increasingly turning towards actively managed factor strategies. SBI Mutual Fund is set to join this cohort with the launch of the SBI Quality Fund (SQF), whose new fund offer closes on February 11.

The fund will invest in companies drawn from the fund house’s research universe of around 450 stocks, selected using a quality-factor framework. This approach focuses on businesses with strong fundamentals, sound governance standards, and sustainable business models. Stock selection will be guided by quantitative quality metrics such as high return on equity, low leverage, consistent earnings growth, strong market positioning, and clearly visible competitive advantages. The other two active quality funds from ICICI Pru MF and WOC MF are with less than a year’s track record and follow similar strategies.

Four-bucket strategy

Beyond these qualitative filters, portfolio construction will be guided by four distinct stock buckets.

The first bucket consists of companies with widening economic moats — businesses whose competitive advantages strengthen over time, often driven by network effects or scale benefits.

The second bucket follows a Quality at Reasonable Price (QARP) approach, targeting high-quality companies available at valuations that are fair relative to their fundamentals. The fund employs both relative valuation metrics such as price-to-earnings, price-to-book, free cash flow yield, and EV/EBITDA, and discounted cash flow (DCF) analysis to assess valuations against peers and intrinsic value.

The third category, termed caterpillar stocks, includes companies that have already built strong and visible economic moats but whose current financial metrics do not yet reflect this strength. These businesses may display subdued earnings or profitability due to industry stress or heavy investment phases. However, advantages such as scale, network strength, or customer franchise position them for future earnings inflection.

The fourth bucket focuses on mean reversion opportunities — high-quality businesses that have suffered temporary setbacks due to business accidents or one-off events.

Active versus passive

SBI Mutual Fund already offers passive variants tracking the Nifty 200 Quality 30 Index — an ETF launched in December 2018 and an index fund introduced less than a year later — together managing assets of around ₹387 crore. The SBI Quality Fund, however, is actively managed, allowing discretion in stock selection and portfolio weights.

The fund manager highlights two key shortcomings of the quality index. First, it ignores earnings growth potential, focusing largely on backward-looking profitability, leverage, and earnings stability. Second, its purely quantitative and backward-looking nature misses qualitative assessments of economic moats. As a result, emerging quality businesses lacking current numbers may be excluded, while companies with deteriorating competitive advantages may remain included. The active fund seeks to address both gaps.

The final portfolio is expected to hold around 30 stocks. While there are no explicit market-cap constraints, the fund is likely to tilt towards large-cap stocks, given the higher concentration of quality businesses. Sectorally, the portfolio is expected to favour industries such as IT, pharmaceuticals, capital goods, consumer goods, and consumer services. In comparison, ICICI Prudential’s quality fund has higher allocations to pharmaceuticals, IT, and banks, while WhiteOak’s quality fund is tilted towards banks, IT, and automobiles. As of December 2025, their large-cap allocations stood at 66 per cent and 47 per cent, respectively.

What should investors do?

The SBI Quality Fund is a thematic offering, and investors should recognise that thematic funds are cyclical and inherently riskier, often going through prolonged phases of underperformance. Quality factors typically lag during speculative bull markets — when momentum favours high-beta, lower-quality stocks — and during sharp value-led rebounds, when distressed companies rally strongly. However, quality strategies tend to perform well during market downturns by offering downside protection through stronger balance sheets, and during late-cycle phases when earnings stability becomes critical. Post-crisis recoveries also often favour quality as investors prioritise sustainable business models.

The current market backdrop appears supportive for the quality factor, which has underperformed value over the past three to four years following the post-Covid rebound. Historically, quality and value exhibit a seesaw relationship: value performs well during early-cycle recoveries and periods of high inflation and quality tends to outperform during growth phases and market downturns.

The fund is benchmarked against the Nifty 200 Quality 30 Index, a strategy known for lower drawdowns and volatility compared with broader market indices. During the global financial crisis of 2008–09, the Nifty 200 fell about 63 per cent, while the quality index declined roughly 54 per cent. Similarly, during the Covid crash, the Nifty 200 dropped 37 per cent, compared with a 28 per cent fall in the quality index.

Over the past 15 years, five-year rolling return data show that the Nifty 200 Quality 30 TRI delivered compounded annualised returns of 15.2 per cent, outperforming the Nifty 50 and Nifty 200 TRI, which returned 13.5 per cent and 14.2 per cent, respectively. Notably, the quality index outperformed the Nifty 50 in 73 per cent of the periods analysed.

Investors seeking exposure to a high-quality equity portfolio with return potential comparable to the Nifty 50 may consider allocating a small portion to this fund. Given its cyclical nature, a minimum investment horizon of seven years or more is advisable. A systematic investment plan may also be considered, especially amid the current uncertain equity market environment.

Published on January 31, 2026