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Smart Beta Funds -Working, Top Funds, Advantages & Disadvantages

  • Akshatha Sajumon
  • 18 Jan
  • 5 minutes

ETFs have been gaining huge popularity in Indian markets over many years. They are considered to be a safe bet for investors who want to earn decent returns but at the same time do not want to take too much risk. However, ETFs do have their own set of shortcomings, one of the main being that they are not able to generate superior returns as they are passively managed investments.

This is where the smart beta funds come in. These funds are relatively new to the Indian markets but have been gaining a strong foothold in developed markets. Read on to know more details on smart beta funds.

What are Smart beta funds?

Smart beta funds or Smart Beta ETFs are an extension of the existing ETF model. This type of investment collaborates the benefits of passively managed funds along with the advantage of selecting investments based on certain formula based rules. This inherent advantage enables the funds to generate higher returns while maintaining the low cost model (which is one of the prime features of a passively managed fund).

Smart Beta funds act as a bridge between actively managed funds and passively managed funds. Like traditional ETFs, smart beta ETFs also track an underlying index for performance. However, the index is altered to provide additional benefits of higher returns than the index. Like ETFs, these funds are also free from any fund manager bias. 

Working of Smart Beta funds

Beta in market language refers to the movement with the market that is represented by an index. The index is customized based on certain underlying factors that are referred to select the securities of the index and assign them with a weightage. Such modification is aimed to provide higher returns or lower volatility.

The factors involved in the formation of the index are mentioned below,

  • Low volatility

Higher weightage is given to low volatile stocks

  • Value

Good stocks that are available at lower prices are also considered while forming the index

  • Growth 

Stocks that have consistently shown growth are selected irrespective of their business cycle.

  • Momentum

Stocks that usually follow the market trend are also given higher weightage in the formation of the index.

The index formed based on these factors is first tested to estimate the possible returns that can be generated. If the results are satisfactory only then they are translated to a functioning smart beta index. 

Advantages of Smart Beta funds

The introduction of the smart beta index was to bridge the gap between actively managed funds and passively managed funds with the idea to provide the advantages of both investment strategies. Some advantages of the smart beta funds are mentioned below.

  • Increased returns as compared to traditional ETFs
  • Lower risk is an inherent feature of ETFs. Smart Beta ETFs also are considered to be low-risk investments as they also track the index for their performance. 
  • Smart-beta funds provide a variety of strategies that can be used by investors to diversify their investment portfolios.
  • The cost of investment or the expense ratio is higher than traditional ETFs but it is still lower as compared to actively managed funds 

Disadvantages of Smart Beta funds

Although smart beta funds are a better investment tool than traditional ETFs, they have certain disadvantages as well. Some of these disadvantages are discussed below.

  • Lower trading volumes as the concept is relatively newer in India
  • Lower liquidity due to lower trading volumes
  • Higher expense ratio as compared to traditional ETFs

Top Smart Beta funds in India

Smart beta funds have shown quite good growth globally with an annual increase of 21.5% in the volume of assets invested in the past five years. In India, though they are relatively new, there are already major fund houses providing smart beta funds for investors. Some of the Smart Beta ETFs/Funds available in India are,

  • Edelweiss ETF – Nifty 100 Quality 30
  • ICICI Pru NV20 ETF
  • Kotak NV20 ETF
  • ICICI Pru Nifty Low Vol 30 ETF
  • Nippon India ETF NV20
  • Sundaram Smart Nifty 100 Equal Weight Fund
  • Principal Nifty 100 Equal Weight Fund
  • DSP Equal Nifty 50 Fund

Conclusion

Smart beta funds sound to be ideal for investors who wish to increase their returns at the same time lower their exposure. However, these funds being new to the market, it is advisable to be cautious of investments as the data to compare and analyze the performance of these funds is still limited. 

FAQs on Smart Beta funds

1. What are smart beta funds?
Smart beta funds are a modified or improved version of traditional ETFs where the fund tracks a customized index that is formed out of securities based on certain specific factors or parameters. The returns generated are thus aimed to be higher than the index while the fund is still in the realm of passively managed funds by having low costs.

2. Are smart beta funds considered to be liquid funds?
Being in the nature of ETFs, these funds are considered to be liquid funds. However, as they have lower trade volumes on account of being relatively new to the Indian market, their liquidity may not be high.

3. Are smart beta funds subject to any tracking errors?
Yes. Smart beta funds also track the underlying index for their performance. Such tracking is subject to certain deviations known as tracking errors.

4. Is the expense ratio lower in smart beta funds?
The expense ratio of smart beta funds is higher than traditional ETFs but is still considerably lower as compared to actively managed funds.

 

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Akshatha Sajumon

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