A Comprehensive Guide To Smart Beta Funds
Introduction
Adding the term ‘smart’ makes something seem more useful and advanced. If you look around, you will find smartphones, smart TVs, smartwatches, smart lights, and other smart products at your home. The investing world also has a smart option known as smart beta funds.
Smart beta funds leverage data-driven insights and systematic methodologies to overcome market challenges. But is investing in smart beta funds a smart investing strategy? You can learn the meaning of smart beta funds, merits, and concerns through this post.
What are smart beta funds?
Smart beta funds use alternative weightage techniques instead of market capitalisation weights. They are also known as strategic beta or factor-based funds. These funds aim to perform better than the market through a unique stock portfolio.
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The term ‘smart’ implies picking and allocating weight to stocks in an index based on research and factor investing techniques. The factors include momentum, size, value, quality, low volatility, etc.
Factor-based funds differ from passive funds as they don’t track indices like the SENSEX or the NIFTY 50. They are actively managed. For instance, a value-based smart beta fund picks companies with stock prices lower than their per-share intrinsic value. It uses metrics like price to sales, PB ratio, PE ratio, dividend yield, etc., for the selection. The factor investing strategy enables smart beta funds to obtain higher risk-adjusted returns than passive funds.
Advantages of smart beta funds
The following advantages can help you determine if these funds are suitable for you.
1. Lower costs
Generally, the fees for smart beta funds tend to be lower than traditional actively managed funds. They seek to give investors the benefits of active management without high expense ratios. Thus, they are a cost-efficient investment option.
2. Increased diversification
Smart beta funds offer more diversification than actively managed funds. Due to this diversification, the risk spreads across several assets and reduces the effect of a single underperforming investment.
3. Focused investment goals
These funds can cater to various investment goals. Their strategies can be tailored. So, you can find a factor-based fund to match your objectives, such as growth, value, or income.
4. Rule-based strategies
Smart beta funds work on predefined and transparent rules. There is no role for human emotions. As a result, decision-making is more consistent.
5. Historical outperformance
Historically, some smart beta strategies have outperformed traditional market indices. This is one reason they attract investors seeking higher returns.
Risks and challenges of smart beta funds
Despite the advantages, some noteworthy risks and challenges associated with these funds are:
1. Market timing: You must time factor-based investments, which isn’t easy to do in rapidly changing market conditions.
2. Crowding: The excess returns can diminish with more assets pouring into smart beta.
3. Factor breakdowns: The strategy can be impacted when factors undergo periods of underperformance.
4. Selection risk: The selection of stocks in smart beta funds depends on specific factors, potentially leading to concentration risk if all those factors fail.
5. No guarantee: Like any other investment vehicle, there is a risk of loss in smart beta funds, too.
Should you invest in smart beta funds?
You can invest in smart beta funds if you’re seeking a cost-effective method of achieving higher-than-market returns. Smart beta funds diversify your portfolio and lower overall volatility. You can set aside 15% to 20% of your portfolio to smart beta funds.
One tip from experts about smart beta fund investments is to track them regularly, as market factors and conditions can change. Moreover, you must be wise and avoid investing your assets in the funds alone. It is also vital to maintain a diversified portfolio to reduce risk, regardless of which investment strategy you follow.
Conclusion
Smart beta funds blend strategies of active and passive investing. Their potential to reduce risks and increase returns has made them quite popular. You must understand these cutting-edge investment instruments to know how they can fulfil your financial goals. While smart beta funds offer a systematic approach based on factors, you must learn that it isn’t a flawless investing strategy. Before proceeding, conduct thorough research and evaluate the risks against your investment objectives.
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