Photo courtesy Tima Miroshnichenko.
Everyone would have heard of index-based investing where the index fund tracks a market cap-based benchmark like the Nifty 50 or Nifty 100. The smart beta methodology is different from traditional market-cap-based investing and is a factor-based investing. In factor-based investing the fund managers target stocks that display a particular characteristic or factor which generates returns. The factors can be like momentum, value, low risk, etc. that can be used alone or in combination to create a basket of stocks. As an example, a fund manager picking stocks based on value may focus on companies whose share price is lower than their intrinsic value and may use metrics like PR ratio, price to sales, or dividend yield.
The factors that may be considered for the formation of a smart beta strategy are–
The stocks that are available at lower prices can be considered while forming the index.
Stocks that have displayed consistent growth irrespective of their business cycles.
Stocks having lower volatility are given higher weightage.
Stocks following market trends are given higher weightage in the index.
Dividend yields are higher than average and still growing.
Stocks display strong profitability characteristics.
The above factors like momentum, value, etc. are not standardized and the mutual fund companies can have their own models to define what momentum or value is. The smart beta fund can also use multiple of these factors for investing.
Smart beta funds were introduced to bridge the gap between actively managed funds and passively managed funds and provide the advantages of both strategies. Most of the smart Beta funds have managed to outperform the Nifty 50 index. The smart Beta funds may consist of single-factor indices or multiple-factor indices. It is the single-factor indices funds that have delivered better returns as these look to maximize returns while the multi-factor indices try to reduce the risks which may lower the returns.
Pros & Cons of investing in Smart Beta funds-
- Investing in a smart beta fund is easier to understand as compared to active investing.
- Since this is a rules-based strategy a lot of emotions are eliminated.
- The returns in smart beta funds are higher as compared to traditional ETFs.
- There are various strategies available in smart beta funds which investors can use to diversify their portfolios.
- The expense ratio in smart-beta funds is lower than the actively managed funds.
- Since the smart beta funds have been introduced a few years back there is not much past data available through the market and business cycles.
- There is lower trading volume as the concept is newer in India.
- Though the expense ratio is low as compared to actively managed funds but is still higher than the ETFs.
Some of the Smart Beta funds/ETFs in India are-
- Edelweiss ETF-Nifty 100 Quality 30
- ICICI Prudential Nifty Low Vol. 30 ETF
- ICICI Prudential NV20 ETF
- Kotak NV20 ETF
- Nippon India Nifty 50 Value 20 Index Fund
- DSP Equal Nifty 50 fund
- UTI Nifty 200 Momentum 30 Index fund.
The number of Smart Beta funds is likely to see an upward launch as more and more people are becoming aware of these funds thereby resulting in the fund houses launching more of such funds.
So how much percent of their portfolio should a person invest in the smart beta funds?
Since these are factor funds a person can diversify across the factor funds. Investing 20-25% of your portfolio in these funds can be a good strategy. The main investments should be in actively managed funds and index funds and the remaining money can be invested in smart beta funds which can provide extra returns. A proper track has to be kept on these funds for the returns.