Smart beta

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Smart beta investment portfolios offer the benefits of passive strategies combined with some of the advantages of active ones, placing it at the intersection of efficient-market hypothesis and classic value investing.[1]

Offering an optimal blend of active and passive styles of management, a smart beta portfolio is low cost due to the systematic nature of its core philosophy - achieving optimal efficiency by way of tracking an underlying index (e.g., MSCI World Ex US). Combining with optimization techniques traditionally used by active managers, the strategy can offer risk/return potentials that are more attractive than a plain vanilla active or passive product.

Originally theorized by Harry Markowitz in his work on Modern Portfolio Theory (MPT), smart beta is a response to a question that forms the basis of MPT - how to best construct the optimally diversified portfolio. Smart beta answers this by allowing a portfolio to expand on the efficient frontier (post-cost) of active and passive. As a typical investor owns both the active and index fund, most will benefit from adding smart beta exposure to their portfolio in addition to their existing allocations.

Demand for smart beta[edit]

Smart beta strategies have generated considerable interest from institutional investors in the wake of the 2008 financial crisis. According to Morningstar, assets under management in 2008 totaled $108 billion rising to $616 billion in 2015.[2]

Product Landscape[edit]

Asset managers including BlackRock, Legg Mason, Henderson Rowe, Invesco and WisdomTree all operate smart beta funds. To identify which type of smart beta provides the best fit, qualified institutional investors need to understand the expected return and risk for each of their active, passive, and smart beta allocations.

Common factor based smart beta types revolve around six ideas for optimization (source: FTSE):

  • Liquidity: Amihud ratio – median ratio of absolute daily return to daily traded value over the previous year
  • Momentum: residual Sharpe ratio
  • Quality: composite of profitability (return on assets), efficiency (change in asset turnover), earnings quality (accruals) & leverage
  • Size: full market capitalization
  • Value: composite of trailing cash-flow yield, earnings yield and country relative sales to price ratio
  • Volatility: standard deviation of 5 years of weekly (wed/wed) local total returns

Smart beta in India[edit]

Smart beta is a relatively newer concept in India. Indian investors don't have a lot of smart beta options to choose. There isn't a lot of awareness about these smart beta strategies either. The Economic Times[3] reports that "smart beta strategies seek to enhance returns from the base index by buying a larger portion of stocks compared to their share in the underlying index." An article in news website Moneycontrol says that a smart beta fund is a passive fund that is benchmarked to an index that is better constructed.

While smart beta strategies are being written about more in the Indian media, investors are not aware much about them. There are only a few smart beta options available to the Indian investor. There are some smart beta mutual funds and smart beta smallcases that investors can choose from.

A blog published in India[4] about smallcases says smart beta strategies aim to increase the returns potential without increasing risks. One of the ways of doing that is by equi-weighting the portfolio of stocks so that each stock gets an equal amount of investment.

Overall, so far smart beta strategies might be new to Indian investors but given their global acceptance, they could turn out to be useful as a passive way to build wealth over the long-term.

External links[edit]


  1. ^ Stewart, James B. (2017-06-22). "An Index-Fund Evangelist Is Straying From His Gospel". The New York Times. ISSN 0362-4331. Retrieved 2017-06-24.
  2. ^ Mooney, Attracta (22 February 2016). "Smart beta 'could go horribly wrong'". Financial Times. Retrieved 23 February 2016.
  3. ^ Dhanorkar, Sanket (2018-12-03). "Are smart beta mutual funds better than large-cap MFs?". The Economic Times. Retrieved 2018-12-19.
  4. ^ "Investing in Smart Beta smallcases". Making smalltalk. 2018-07-21. Retrieved 2018-12-19.