The Indian mutual fund industry has witnessed significant growth in recent years, with assets under management (AUM) crossing ₹66.70 trillion as on 31st Aug 2024. Within this growing industry, a new trend is emerging viz. Smart Beta funds. These funds combine the benefits of passive investing with the potential for active returns, making them an attractive option for investors seeking diversification and improved risk-adjusted returns.
What are Smart Beta Funds?
Smart beta funds, also known as factor-based investing, use alternative weighting strategies to select stocks, unlike traditional market-capitalization-based indices. These funds aim to exploit specific factors such as value, momentum, quality, or volatility to generate excess returns over the traditional index like the Nifty 50 or BSE Sensex.
Let’s take the Nifty 200 Momentum 30 as an example. It’s a smart-beta fund that looks at all the 200 companies in the Nifty 200 and then identifies 30 stocks with the strongest ‘momentum’ score. Similarly, a Nifty 100 Low Volatility 30 fund finds the 30 least volatile stocks among the 100 companies in the Nifty 100.
Factors and what they mean
Value – Stocks with lower P/B, P/E, or some other valuation metric
Volatility – Stocks with lower standard deviation / beta
Momentum – Momentum considers the stock’s returns in the last six and 12 months, adjusted for its volatility. It’s about stocks rising quickly and with the potential for further success.
Quality – Companies that have higher return on capital and earnings growth. Companies with lower debt to equity are preferred.
Size – In this case, stocks are categorised as per their market capitalisation (market cap)
Please note that the definition of each factor may vary from fund to fund and one should check each product before investing in it.
Emergence of Smart Beta Funds in India
The Indian market has seen a surge in smart beta fund launches in recent years. According to a recent report by ET, there are now 57 smart beta funds in India with AUM of over Rs 16,000 cr (as on 3rd April 2024). This growth can be attributed to several factors:
- Investor demand for diversification
- Increased awareness of factor-based investing
- Regulatory support from the Securities and Exchange Board of India (SEBI)
- Growing competition among asset management companies (AMCs)
- Attractive mix of active and passive funds
- Strong recent performance of Smart Beta funds
Benefits of Smart Beta Funds
Smart beta funds offer several benefits to investors, including:
- Improved diversification
- Potential for excess returns
- Risk management
- Transparency and rules-based approach
- Lower costs compared to Active funds
Challenges and Limitations
While smart beta funds offer promising benefits, there are also challenges and limitations to consider:
- Lack of standardization
- Complexity
- Higher costs compared to traditional index funds
- Limited track record in India
- Possible cyclical nature
Performance of Smart Beta Funds
| Factor | Fund* | 1Y returns (%) | 3Y returns (%) |
| Momentum | UTI Nifty200 Momentum 30 Index Fund | 58.96 | 22.77 |
| Benchmark | Nifty 200 index | 53.30 | 15.71 |
| Size | DSP Nifty 50 Equal Weight Index Fund | 36.14 | 18.85 |
| Benchmark | HDFC Index Fund Nifty 50 Plan | 26.56 | 13.89 |
| Size | Sundaram Nifty 100 Equal Weight Fund | 45.44 | 18.38 |
| Benchmark | Axis Nifty 100 Index Fund | 31.48 | 14.14 |
| Value | Nippon India Nifty 50 Value 20 Index Fund | 37.19 | 18.10 |
| Benchmark | HDFC Index Fund Nifty 50 Plan | 26.56 | 13.89 |
| Volatility | Bandhan Nifty100 Low Volatility 30 Index Fund | 37.17 | NA |
| Benchmark | Axis Nifty 100 Index Fund | 31.48 | 14.14 |
| Quality | DSP Midcap 150 Quality 50 Index Fund | 34.32 | NA |
| Benchmark | Nippon India Nifty Midcap 150 Index Fund | 45.17 | 25.24 |
Returns are annualised. Data is as on 17th Sept 2024. Source: valueresearchonline.com.
*For the funds selected, Regular Plans have been considered. Index funds chosen above (including the benchmarks) are the best performing in their respective category. Instead of using the actual nifty indices as benchmarks (like Nifty 200 TRI), Index Funds have been chosen to account for the impact of expenses (like to like basis).
Mutual Fund investments are subject to market risks. Please read all scheme related documents carefully before investing.
View point
Smart-beta funds are still a very nascent concept and need to be time-tested through long market cycles. One and three year periods are too small to evaluate the performance and solidity of this category of funds. Further some of the factors driving these funds are cyclical thereby making some of them more risky. However given their enhanced performance (albeit over a short period), one may start allocating 5-10% of their investments to these preferably on the guidance of a financial planner or distributor.
Conclusion
The emergence of smart beta funds in India marks an exciting development in the country’s mutual fund industry. As investors seek diversification and improved risk-adjusted returns, smart beta funds are likely to continue growing in popularity. However, it is essential for investors to understand the benefits and limitations of these funds and to carefully evaluate their investment objectives and risk tolerance before investing.
Rohin Pagdiwala
Financial Distributor & Founder of Pagdiwala Investments
info@pagdiwalainvestments.com
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