Thus, Smart Beta is a rule-based investing strategy that combines some of the principles of active management (i.e. factors used in stock selection) with a passive approach. By combining characteristics of both passive and active investing, Smart Beta strategies allow investors to retain benefits of passive strategies while seeking outperformance and/or risk premia over a simple traditional market cap-based benchmark index which focuses on just beta.
The Nifty100 Index represents the top 100 companies based on full market capitalisation and measures the performance of large market capitalisation companies where the weight of each stock is based on its free-float market capitalisation. A Smart-Beta Index like the Nifty 100 Low Volatility 30 Index tracks the performance of the 30 least volatile stocks in the NIFTY 100 Index and aims to generate risk-adjusted returns based on a portfolio of stocks that are characterised by lower volatility.
Here the stocks are not only selected but also weighted as per volatility score. On the other hand, the Nifty 100 Alpha 30 Index, selects and tracks stocks based on higher Alpha over the benchmark index.
Now, when it comes to Smart Beta ETFs, they aim to potentially combine the benefits of both active and passive investing. Nifty100 Low Volatility 30 Index is a Smart Beta ETF that aims to measure the performance of the low volatile securities in the large market capitalization segment.
Smart Beta ETFs are gaining popularity across the globe as they have the potential to generate alpha by using different factors. They have grown at a CAGR of around 24.1% over the last five years.
The total number of ETF products based on plain vanilla market capitalization is around 4,912 whereas the total number of ETF products based on Smart-Beta Strategies is around 1,275. Market Cap ETFs have grown at a 5-years CAGR of around 23.7%. Low volatility, a factor-based investment has performed well during market downturns and recessionary phases. Low volatility works well in long-term horizons, too. In a bull market, a momentum-based strategy works well but may underperform significantly in the time of correction. A low-volatility portfolio typically has lower churn whereas a momentum portfolio typically has higher churn and volatility.
By achieving a specified high level of exposure to targeted factors, it aims to produce desired risk and return profile as each of the smart beta strategies provides a systematic risk-adjusted return premium.
Smart Beta-based passive investment strategies are increasingly being used by investors across the globe as building blocks in their asset allocation models in their quest to outperform the market either on an absolute basis or on a risk-adjusted basis or both.
Each of the Smart Beta strategies aims to provide a systematic risk-adjusted return premium by achieving a specified high level of exposure to targeted factors and aims to produce desired risk and return profile, portfolio diversification, and return enhancements relative to traditional market capitalisation benchmarks.
But at the same time, every strategy has its unique strengths and limitations. There can seldom be a single investment strategy that would outshine other strategies consistently in all market conditions.
With the introduction of Smart Beta strategies like Low Volatility, Value, Quality, etc, investors can now gain access to many of the same time-tested investment ideas that have been present in actively managed portfolios for decades, in a transparent and rules-based vehicle and at a lower cost than traditional active management.
