Market regulator SEBI is likely to come out with guidelines on smart beta ETFs, said Ananta Barua, Executive Director, SEBI on the sidelines of Asia Index event held in Mumbai.
“It will address issues related to market making and liquidity,” Barua told Cafemutual.
Unlike regular ETFs which merely mimic a particular index, smart beta ETFs try to generate returns slightly higher than ETFs within the framework of passive management. This is a relatively new category in the Indian ETF landscape.
Such products are one of the fastest growing categories in the international markets. A BlackRock report shows that as of December 2014, there are more than 700 smart beta ETFs listed around the globe, with $529 billion in assets.
Indian fund houses are also trying to bring smart beta index funds/ETFs in India and SEBI is of the view that there is a need for bringing new rules for this emerging category to ensure such innovations don’t pose a risk to investors. “Based on inputs from experts or participants, if there is any need that further changes are required for rules and regulations of ETFs, SEBI will be more than willing to listen to you and incorporate those changes. We have to be conscious that those types of innovation where higher risk are being taken in some of the countries outside India, we are able to avoid,” SEBI Chief U K Sinha was quoted in Times of India recently.
For instance, SBI Mutual Fund has sought SEBI approval to launch SBI Enhanced Index Fund – Minimum Variance. The fund will select stocks based on a combination of risk & factor based parameters like portfolio volatility, correlation & covariance. The minimum variance strategy aims to minimize the portfolio volatility based on correlation & volatilities of the stocks in the portfolio, states the fund’s offer document. The portfolio of this fund will be reviewed on a periodic basis and the portfolio could change due to entry or exit of certain stocks. To reduce the volatility, the fund will also invest in derivatives and hedging products.
“It is meant for investors who are looking for slightly higher returns than regular ETFs. The fund will choose certain stocks with some filters. It is a new category in the ETF space,” said Dinesh Khara, MD & CEO, SBI Mutual Fund.
SBI has filed another offer document for SBI Enhanced Index Fund – Maximum Sharpe Ratio. The fund will select stocks from an underlying index based on parameters like Sharpe ratio, correlation and covariance.
Reliance MF has also launched smart beta ETF called R*Shares NV20 ETF. The NV20 ETF consists of 20 most liquid value blue chip companies (with exposure to 8 sectors) which are a part of CNX Nifty Index. The NV20 ETF selects stocks by looking at parameters like return on capital employed (ROCE), price to equity ratio, price to book value ratio, dividend yield and so on.
Other fund houses like ICICI Pru and Kotak have also filed offer documents with SEBI to launch NV20 index funds.
Smart beta ETF/funds try to instill some characteristics of an equity fund in a passive fund. Such funds select stocks based on predetermined filters. Simply put, smart beta ETFs aim to provide the best of both worlds – low cost of ETFs and enhanced returns of active funds.
"Smart beta ETFs are very popular globally and BlackRock iShares is one of the leading players in this space. In India, since the overall ETF industry is in a nascent stage, the smart beta ETF category may take some time to grow. Such funds can be looked at as a combination of active and passive investing, because they try to seek improved returns or reduced risk by smart selection of stocks within an index. Also, such funds allow you to apply filters which would best suit your investment objective,” said Anil Ghelani, Senior Vice President, DSP BlackRock Investment Managers.
Since such funds are somewhat active in nature, the expense ratio could be higher than ETFs but lower than actively managed funds. In turn, the turnover ratio or the churning ratio of such funds would naturally be higher.
One of the drawbacks of traditional ETFs is that they have exposure to underlying stocks which are weighted solely on market capitalization. Thus, the traditional ETF can be overweight on expensive stocks & underweight on cheap stocks. Smart beta ETFs try to fix this problem by using some attributes of active management.
Fund officials believe that the category will see launch of more such products by AMCs. It remains to be seen how quickly investors lap them up.
