MIDDLE GROUND

Smart beta strategies blend the best of both investing worlds-active and passive funds

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Over the decades, equity investing in India has primarily been driven by two major types of funds: active funds and passive funds.

Active fund managers typically use a combination of research, judgment, and experience to decide which stocks to buy or sell and construct their portfolios. Passive funds track market indices (such as the Nifty 50 or Nifty 500) and charge low fees for doing so.

But in recent years, a new style of investing has become increasingly popular: smart beta or factor-based investing. Smart beta strategies aim to create a hybrid fund that combines the benefits of passive investing and systematic selection with the potential for superior returns by employing data and predefined rules rather than the traditional human judgment that has been the basis for active fund management.

WHAT SMART BETA AND FACTOR FUNDS ACTUALLY ARE

In contrast to traditional index funds, which weigh stocks based solely on their market capitalization, smart beta funds weigh stocks based on factors that correspond to measurable characteristics associated with superior long-term returns or lower risk.

Factors such as growth, value, quality, momentum, volatility, and size reflect these measurable characteristics and typically utilize a rules-based set of criteria to select and weigh stocks in an index based on how closely they fit those criteria. By requiring investors to choose which characteristics they want to use as a lens for defining their portfolios, smart beta strategies remove a layer of investor psychology from the traditional index fund model and enable them to create their own definition of their respective markets.