An Introduction to Smart Beta Funds

Smart Beta products are a type of ETF that utilises a rules-based system to select suitable investments to be included in the fund’s portfolio. These ETFs is build on traditional ETFs but the fund’s holding pattern is based on pre-determined financial metrics.

Each smart beta product’s governing rules vary based on the established rules at the fund’s inception.

Smart beta products do not involve the basic cap-weighted index strategy. They consider granular factors specific to any company or industry to serve the purpose. They choose companies which only exhibit some behaviours or metrics, including factors like the stock’s momentum, earnings growth, stock’s variations, profitability, etc. Based on these characters, each stock has a different weight.

Types of Smart Beta ETFs

Smart beta ETF products can screen and choose holdings based on different aspects. There are several types of smart beta products; some most common ones are as follows:

  1. Equally weighted – Despite weighting funds based on stock price and market capitalisation, this strategy is used for similarly weighting factors and holdings.
  2. Fundamentally weighted – Companies get selected and weighed by factors that includes profits, total earning, revenue, and financially determined metrics and fundamentals.
  3. Factor-based – Weighting of stock is done based on certain factors like the under-priced valuations, balance sheet components, or smaller growing companies.
  4. Low volatility – It focuses mainly on stocks with lower volatility or small pricing fluctuations for a period.

Benefits of Smart Beta products

  1. Smart Beta products are specially designed to increase portfolio returns, maximise dividends, and lower portfolio risks.
  2. Using Smart beta strategies also helps in using equally weighted indexing.
  3. Smart beta products do not follow passive strategies like traditional index funds that depend on market capitalisation.
  4. These are beneficial for investors wishing to increase their income and returns while minimising risks.

Conclusion

Smart beta products are comparatively new in India but are well established and accepted globally. These strategies look forward to outperforming the typical index. We can consider them as a middle ground between active and passive investing styles. Smart beta fund’s portfolio doesn’t have too many stocks; it only has stocks of limited companies that meet a specific criterion.

Smart-beta funds are transparent and highly depend on a fixed set of rules when it comes to selecting stocks. They have also showed the capabilities to beat the market with lower risk and cost than the other funds.

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