What are Smart Beta Funds? Meaning, Benefits and How it Works

The new age calls for smarter solutions - smartphones, smart home appliances, and now, smart funds. In a world where traditional tools are quickly being replaced by more sophisticated options, mutual funds are evolving, too. Smart beta funds are a testament to this shift with a new-age strategy that goes beyond what traditional mutual funds provide. Let’s explore what these funds are and whether they might be the right fit for you.

What are smart beta funds, and what sets them apart from traditional funds?

Smart beta mutual funds are a twist on traditional investing. Unlike conventional mutual funds that simply track a market-cap-weighted index, smart beta funds use alternative strategies to build their portfolios.

These funds rely on factors such as value, quality, momentum, volatility, or equal weighting to select and rebalance stocks. Instead of following a benchmark index, they track customised indices based on specific rules.

How do smart beta funds work?

Smart beta mutual funds work differently from traditional mutual funds that rely on market capitalisation to assign weight to stocks. Instead of giving higher weight to larger companies, smart beta funds use a rules-based approach to select and weight stocks. They use specific factors such as value, momentum, low volatility, quality, etc.  

For instance, an equal-weight Nifty 50 fund would invest in all 50 Nifty companies but assign each one an equal weight. A smart beta fund might screen stocks based on earnings stability and give more weight to companies with stronger fundamentals.

Smart beta funds use such factor-driven strategies to reduce risk and avoid overexposure to specific types of stocks. They aim to potentially deliver better risk-adjusted returns over the long term.

Key benefits of smart beta funds

Here are some benefits of investing in smart beta funds:

• Diversification: Smart beta funds focus on specific investment factors when creating their portfolios. This approach can offer exposure to different market segments that traditional index funds might not provide. Investing in them can help you diversify your portfolio.
• Flexibility: You can choose to invest in smart beta mutual funds or smart beta ETFs based on your investment style.
• Low risk: Smart beta strategies may prioritise low-volatility stocks. This can help reduce overall portfolio risk during market downturns.
• Transparency: Smart beta funds follow a rules-based strategy. The stock selection and weighting process is data-driven. This reduces emotional decision-making. You can clearly see the strategy being employed and understand why the fund is investing in a particular stock.
• Cost-effectiveness: Compared to actively managed mutual funds, smart beta funds often have lower expense ratios. They offer a cost-efficient way, which makes them attractive for long-term investing.

Who should consider investing in smart beta funds?

Smart beta funds are well-suited for investors who want to go beyond traditional index investing and explore factor-based strategies. These funds can be a good choice if you are aiming to diversify your portfolio with exposure to specific factors like value, quality, or momentum.

If you want the potential for better returns without taking on too much additional risk, smart beta funds could be a nice fit in your mutual fund portfolio. They are also suitable if you prefer a long-term, rules-based investment strategy that removes emotional decision-making and helps you stay on track with your financial goals.

Conclusion

Smart beta funds offer certain advantages that traditional mutual funds may not, such as factor-based diversification and the potential for improved risk-adjusted returns. However, it is important to remember that these funds still carry some risks and do not guarantee better return than traditional mutual funds.

Additionally, the strategies they use can sometimes be complex and may not be easy for every investor to understand. So, before you invest in smart beta mutual funds, make sure you research thoroughly and understand the specific approach the fund follows to ensure it aligns with your financial goals and risk tolerance. In case of any doubts, you can speak to a financial advisor and check whether investing in them is the right choice for you.

An investor education initiative by Edelweiss Mutual Fund

All Mutual Fund Investors have to go through a one-time KYC process. Investors should deal only with Registered Mutual Fund (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit - https://www.edelweissmf.com/kyc-norms 

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME-RELATED DOCUMENTS CAREFULLY