Smart Beta ETFs: A trend or the future of investing?

Today, we will discuss what are smart beta exchange-traded funds (ETFs) and whether you should invest in them.

The Story

In today’s era, where everything is evolving “smartly”, including smartwatches, glasses, and televisions, we also have come to the verge of smart investing. One such smart investment option is Smart Beta ETFs.

In India, there are 56 Smart Beta funds (across ETFs and index funds) that manage assets worth ₹15,996 crore.

But before we discuss them in more detail, let’s understand the underlying instrument: Exchange-Traded Funds (ETFs).

💡 ETFs are a basket of securities trading on an exchange. Just like index funds, when you buy ETF shares/units, you are buying shares of a portfolio that tracks the returns of its benchmark index.

Smart Beta ETFs are a bit ahead of standard ETFs. They are a type of ETF that uses rules-based strategies to track a specific market factor, aiming to outperform traditional market-cap-weighted indexes.

Let’s understand them in detail.

Understanding Smart Beta ETFs

Smart Beta ETF includes active strategies for higher returns and passive strategies to create wealth

They work by selecting and weighing stocks using specific factors, predetermined rules, and strategies rather than following a standard market index. This increases the potential returns.

The primary goal of smart beta ETFs is to offer better returns than traditional passive funds at a lower cost and active management.

To achieve this, the selections of stocks should be transparent and follow a set of rules and factors rather than hindered by the fund manager’s subjective choices.

Smart-beta ETFs have six factors or rules for selecting stocks from a particular index.

Performance of Smart Beta ETFs

The table shows the comparison of four smart beta ETFs along with their expense ratios and standard ETFs from the same fund house.

The Kotak NV 20 ETF has given a return of 17.51%, while the standard Kotak Nifty 50 ETF has given only 12.44%

Likewise, ICICI Prudential NV 20 ETF has offered 18.43%, while the standard ETF (ICICI Prudential Nifty 50 ETF) has given only 14.15%.

This is because the factor index NV 20 has outpaced its parent index NIFTY 50 by 97%, based on the 5-year rolling returns between Jan 31, 2019, to Jan 31, 2024.

The DSP Nifty 50 Equal Weight Index Fund/ETF has only 13.17% as compared to the standard DSP Nifty 50 ETF, which stands at 12.79%.

To Conclude

Smart Beta ETFs offer a middle ground between active and passive strategies by leveraging rule-based strategies to enhance returns.

While their performance often outshines standard ETFs, the key to maximizing potential lies in choosing the right factor that aligns with your financial goals and risk tolerance.