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While a lot of debate on mutual funds is regarding whether to choose between active and passive funds, a special type of passive funds offers the benefits of both active and passive funds. These are smart beta funds. A whitepaper released by Nippon India MF explains the basics of smart beta funds, various smart beta strategies and the benefits of adding them to your portfolio.
What are smart beta funds?
Smart beta funds are special funds that replicate or track strategy indices. The underlying index utilizes specific strategies to enhance returns and manage risk. They offer investors options to invest in specific market segments based on their investment objectives.
Generating alpha with smart beta funds
While alpha is generally associated with active funds, smart beta funds are based on non-traditional indices designed to potentially beat the market. Hence, they are able to generate alpha compared to traditional passive funds.
Strategies of smart beta funds
Smart beta offers various strategies that can be used to create unique portfolios. The table below explains various strategies of smart beta funds and the potential outcomes that investors can expect by investing in them.
|
Strategy |
Focus |
Potential Outcome |
|
Value |
Undervalued stocks |
Gains as market corrects undervaluation |
|
Growth |
High-growth stocks |
Capital appreciation as growth materializes |
|
Quality |
Strong fundamentals |
Stability and consistent returns |
|
Momentum |
Upward price trends |
Capitalize on ongoing price movements |
|
Dividend opportunities |
High dividend-yielding stocks |
Regular income and potential appreciation |
|
Alpha |
Excess returns over market |
Outperformance of traditional benchmarks |
|
Low volatility |
Low price fluctuation |
Reduced risk and smoother returns |
|
Equal weight |
Equal exposure to all stocks |
Enhanced diversification and risk management |
Source: Nippon India MF
Value: The value factor aims to invest in stocks that have a lower stock price than their intrinsic value. The parameters used to select such stocks include P/E ratio, price to book value ratio, dividend yield. Benchmark indices for this factor include Nifty 50 Value 20, Nifty 200 Quality 30, Nifty 100 Quality 30.
Growth: The growth factor smart beta fund explores investment opportunities in companies that are expected to grow their earnings at an above-average rate. The parameters for selection of stocks include Earnings per Share (EPS) growth, P/E ratio, Return on Equity (ROE). Benchmark indices for this factor include Nifty Next 50 index, Nifty 50 index and Nifty 500 index.
Quality: The quality factor aims to invest in stocks with strong fundamentals and profitability characteristics. The parameters used for stock selection includes return on equity, dividend growth, strong balance sheet and cash flows. Benchmark indices for this factor include Nifty Midcap 150 Quality 50, Nifty 200 Quality 30 and Nifty 100 Quality 30
Momentum: The momentum factor invests in strong past performance in the last 6 months. It selects stocks based on parameters like point-to-point returns and past alpha generation. The benchmark indices for this factor include Nifty 200 Momentum 30.
Dividend opportunities: This factor invests in high dividend-yielding stocks with an aim to provide regular income and potential appreciation. The benchmark indices for this factor include Nifty Dividend Opportunities 50.
Alpha: This factor invests in stocks that outperform traditional indices. Benchmark indices for this factor includes Nifty Alpha 50, Nifty100 Alpha 30, Nifty Alpha Low Volatility 30 and Nifty Alpha Quality Low-volatility 30.
Low Volatility: This factor invests in stocks that provide lower price fluctuation to reduce risk in the portfolio. The parameters for selection include standard deviation and beta. Benchmark indices for this factor includes Nifty Alpha Low Volatility 30, Nifty100 Low Volatility 30, Nifty Low Volatility 50, Nifty Alpha Quality Low Volatility 30.
Equal Weight: This factor uses the investment strategy of assigning equal weight to each stock in the portfolio, regardless of its market cap. This helps to create a more diversified portfolio in which smaller stocks also have an impact. Benchmark indices for this factor includes Nifty 50 Equal Weight Index, Nifty Next 50 Equal Weight Index and BSE Sensex Equal Weight Index.
