What are Smart Beta Funds? Should You Invest in Smart Beta Funds?

In this article we will be discussing about the Smart Beta Funds, what is it, and whether one should invest or not?

What are Smart Beta Funds?

• Smart Beta Funds are factor-based investing formula. These funds can be based on any of the factors and have certain rules for the same as well.
• These funds are also termed Strategic Termed Investing.
• Some of the common factors on which these funds are based are Value, Dividend, Momentum, etc.

What are the Factor Metrics:

1) Value:

• As per the value factor, the stocks are characterized based on Low Prices as compared to fundamental/intrinsic value.
• Metrics used in these factors are PE Ratio, PB Ratio, Price to Sales Ratio, and Dividend Yield.

2) Quality:

• As per the Quality factor, the strong profitability metrics matter.
• Return on Equity (ROE), Debt Equity Ratio, EPS Growth, Dividend Growth, Financial Leverage, Cash Flows, and Strength of Balance Sheet is carefully considered.

3) Momentum:

• Here, the score is being calculated based on the strong past performance of the stock for the last 3-6 months for the selection of the stock.
• Common metrics used are Point to Point Returns and Historical Alpha.

4) Low Volatility:

• In these funds, the stock is selected based on the below-average or low volatility.
• Here, Standard Deviation and Beta are the important metrics.

List of Multi-Factor Indices:

In this segment, we will see some indexes based on these factor-based investing formulas, which are:

1) Nifty Alpha Low-Volatility 30:

• In this index, the Alpha factors weigh 50% and the Low-Volatility factors weigh around 50% of the fund.
• The parameter used is High Jensen Formula.
• The data source for this index is the last 1 year's stock prices and the condition is 1-year pricing history.

2) Nifty Quality Low-Volatility 30:

• In this fund, the weightage is divided between Low-Volatility and Quality factors which account for 50% of weightage each.
• Some common parameters here are High ROE, Low D/E Ratio, and Low EPS Growth Variability.
• Data Source is Annual Report and conditions applied is there should be positive Earnings Per Share (EPS) in the last 6 Financial Years.

3) Nifty Alpha Quality Low-Volatility 30:

• In this fund, the weightage is divided between 3 factors namely Alpha, Quality, and Low Volatility where each factor accounts for 33.33% of weightage.
• Parameters used for this fund are High Return on Capital Employed (ROCE), Low P/E, Low P/B, and High Dividend Yield.
• Data Source is Annual Report and the conditions applied is there should be positive Profit After Tax (PAT) in the previous financial year.

4) Nifty Alpha Quality Value Low-Volatility 30:

• In this fund, the weightage of the factors is as follows: Alpha (25%), Low- Volatility (25%), Quality (25%), and Value (25%).
• Low Standard Deviation of Price Returns is the commonly used parameter here.
• The Data Source for this fund is 1-year stock prices, and the conditions applied are 1-year pricing history.

Growth of Smart Beta Funds and ETFs in India:

• Currently, there are 20 Smart Beta Funds as of February 2022 which include 5 Equal-Weight Funds and 2 Fund of Funds.
• The count of Smart Beta Funds was just 2 in December 2014, 8 in December 2019, and 17 in December 2021.
• Along with the number of smart beta funds, its Asset Under Management has been also increased exponentially.

Smart Beta Funds and ETFs in India:

Some of the common Smart Beta Funds and ETFs in India along with their AUMs, Expense Ratio, and Past Returns are:

Pros and Cons of Investing in Smart Beta Funds:

Positives:

1) These funds majorly cover large caps only.

2) Unbiased Stock Selection

3) Good historical performance

4) Low Expense Ratios

Negatives:

1) Very new to check the consistency.

2) Low Liquidity in ETFs

Should You Invest in Smart Beta Funds:

Smart Beta Funds are fast-growing funds but most of these funds are quite new and hence the only problem associated with these funds is their no past records. But the funds with the longest history have performed well which gives some comfort to the investors as well.

Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.

Originally Published On: https://blog.investyadnya.in/what-are-smart-beta-funds/