Why should you have ‘Smart Beta Funds’ in Your Portfolio?

In this article we introduce Smart Beta Funds to you, an innovative investment option that has the potential to add a lot of value to your portfolio. Here’s a comprehensive look at what Smart Beta Funds are, their advantages, and why they might be the right choice for you.

Understanding Smart Beta Funds

Smart Beta Funds are a unique breed in the world of investing and combine elements of both active and passive investing. Unlike traditional index funds that simply track a market index, Smart Beta Funds follow a set of predefined rules or strategies to select and weigh stocks. These strategies aim to outperform the market or achieve specific investment objectives like a goal, entering a specific domain or investing philosophy, or maybe even just bringing a bit of zing to the overall portfolio.

Exploring Smart Beta Factors: The Building Blocks of Returns

Smart Beta Funds rely on specific factors to construct their portfolios. These factors are like the secret ingredients that determine a fund’s performance. Here are some common factors:

1. Value: This factor seeks out low-priced stocks relative to their fundamental value using metrics like the P/E ratio, P/B ratio, P/S ratio, and Dividend Yield.
2. Dividend Yield: Favors companies with above-average and growing dividend yields, focusing on stocks that provide consistent income.
3. Size: Considers market capitalization, categorizing companies based on their total or free-float market capitalization.
4. Momentum: Focuses on stocks with strong past (near and earlier) performance, considering past returns and historical alpha.
5. Low Volatility: Targets stocks with below-average volatility, taking into account metrics like standard deviation and beta.
6. Quality: Examines stocks with strong profitability characteristics, using metrics like return on equity, earnings stability, and balance sheet strength.When Smart Beta Makes Sense.
7. Diversification: Smart Beta Funds are ideal for building a well-rounded portfolio without high fees. They offer a very cost-effective way to diversify your investments across various assets.
8. Specific Goals: If your investment objectives are clear, such as targeting value or generating income, Smart Beta Funds can be customized to align perfectly with these goals.
9. Risk Tolerance: If you are comfortable with the inherent risks of investing and have a long-term outlook, Smart Beta Funds provide a balanced approach that combines elements of both active and passive strategies.

Smart Beta Funds can be a valuable addition to your investment portfolio, offering diversification, cost-efficiency, and tailored strategies. However, like any investment, they come with unique risks too but they can be mitigated with good research and constant monitoring of the market niche they’re operating in.

Advantages of Smart Beta Funds

1. Enhanced Diversification: Smart Beta Funds often have a more diversified portfolio compared to traditional actively managed funds. This diversification helps spread risk across various assets, reducing the impact of any single underperforming investment.
2. Lower Costs: These funds generally come with lower fees compared to actively managed funds. They offer the benefits of active management without the high expense ratios.
3. Rule-Based Strategies: Smart Beta Funds operate on transparent, predefined rules, eliminating human emotions from the investment process. This can lead to more consistent decision-making and potentially better performance.
4. Specific Investment Goals: Smart Beta Funds can be tailored to meet specific investment objectives. Whether you are looking for income, growth, or value, there is likely to be a Smart Beta Fund designed to match your goals.
5. Historical Outperformance: Some Smart Beta strategies have a history of outperforming traditional market indices all through, appealing to investors seeking higher returns.

Disadvantages of Smart Beta Funds

1. Lack of Active Flexibility: While Smart Beta Funds use active strategies, they are not entirely active and may have a lag in adapting to changing market conditions or emerging opportunities.
2. No Guarantees: As with any stock-market related investment, Smart Beta Funds come with their own specified risks. Past performance is no guarantee of future results, and some strategies may underperform or even experience losses.
3. Complexity: The rules and strategies used by Smart Beta Funds can be complex for an average investor to fully understand. This complexity can make it challenging to assess whether a specific strategy aligns with your goals or not.
4. Limited Track Record: Some Smart Beta strategies have a limited track record, making it difficult to evaluate their long-term performance and reliability.

When you need to Be Cautious with Smart Beta Funds

1. Lack of Understanding: Since Smart Beta strategies could be a bit challenging to understand for a common investor, it might be the best to rely on your financial advisor’s advice for such funds who would be researching and monitoring this space on a regular basis.
2. Short-Term Goals: If you have short-term investment goals or need liquidity in the near future, Smart Beta Funds may not align with your needs.
3. Preference for Full Control: If you prefer hands-on control of your investments, Smart Beta Funds may not provide the flexibility you desire since they work on a passive format.

How would they suit your portfolio

Considering the current scenario where the country’s economy is on an extended growth path, likely for a long term, Smart Beta Funds have the potential to provide good alpha (ie, additional returns over benchmarks) with their focused approach, while being cost-effective due to their lower expenses than regular active funds. If you’re ready for taking a bit of a thematic approach, of course with our complete guidance backed by a diligent research and careful monitoring, we would recommend you to take this route as a useful addition to your current portfolio.

If you’re fine with this, please contact your financial advisor in the company to discuss integrating Smart Beta Funds into your portfolio, who will take you ahead with an exposure to this new and good way of investing.

Please remember that we do not recommend you taking out any money from your current portfolio and disturbing its carefully crafted balance. You should go in for Smart Beta funds with additional amount or SIP, not forming anything more than 10% of your overall invested amount or SIPs respectively.