Investors' Hangout: What are smart-beta funds?

What are smart-beta funds?
The term 'smart' essentially comes from the contrast with being 'dumb.' To grasp what a smart-beta fund is, one must first understand the concept of a beta. Beta refers to the returns generated by taking no extraordinary risks—if your portfolio is aligned with the index, you achieve what is known as beta. It's a measure of volatility, with an investment that moves in tandem with the index considered as having a beta of one. A beta of two indicates twice the volatility, and a half suggests half as volatile. Smart-beta funds aim to enhance the index, making it a more appealing story capable of generating superior returns in a predictable manner. In India, there are over 30 types of smart-beta funds, with equal-weighted indexes being the most common. These funds aim to give all constituents equal opportunity, potentially benefiting from a reversion to mean. Other variations include alpha funds, low volatility funds, and momentum index funds, which have been the most popular in the last financial year or calendar year.

Smart-beta funds represent a semi-active management style with a disciplined approach based on a set of rules and an underlying index. However, these funds are not immune to market downturns. So, nothing prevents the smart-beta funds from insulating them from the declining phase of the market. Many mutual funds are launching these funds also because they're finding it difficult to beat the index many times. These are the kinds of funds that, if you're able to create one, you can launch without worrying about SEBI's classification rule because there is no such restriction here.

What are the benefits and drawbacks of smart-beta funds?
The benefits of smart-beta funds include their disciplined nature and predictable behaviour within set parameters. However, a drawback is their inability to capture unique opportunities outside their predefined universe, flexibility that actively managed funds possess.

Who should invest in these funds?
Smart-beta funds should be evaluated like any other equity fund. Investors should assess them objectively to determine if they align with their investment goals.

Addressing viewer's query
Hardeep Sidhu asks, 'I'm a science teacher in a government school, my current salary is Rs 72,000 per month, and around Rs 18,000 of it gets deposited in NPS Tier-I. I'm thinking of taking a personal loan of Rs 5 lakh from the bank at the rate of 10.25 per cent to invest in stocks by buying the Value Research portfolio plan for three years. He also says that in case of market correction around 10 per cent, I can take another Rs 5 lakh loan, and I want to stay invested for eight to 10 years.'

It's a good idea, but don't do this. You should never invest with borrowed money because the odds are against you. Assuming that you borrow Rs 5 lakh and invest, it becomes Rs 8 lakh in two years, which is good news, and after that, it will also crumble sometimes and become Rs 4 lakh overnight or in two weeks. That is the time when you will actually run out of ideas. Good times make you happy, but that kind of steep decline in a brief period will drive you out to the market.

The other reason you cannot be patient with your borrowed money investment is that you have to pay interest on that capital.

Further, there is NPS. In NPS, 10 per cent of your salary is deducted. The government provides 14 per cent, and it goes into that investment account. So far, these contributions have been getting invested in the state government or the central government plan, where the equity component was only 11 percent. Now, it is possible to invest in a plan, which is the lifecycle fund, and if you invest in the lifecycle fund, and if you're young, then it can have far higher allocation than 11 per cent. It can well go up to 30-50 per cent.

Moreover, instead of borrowing, do some parallel savings. Do your SIP. Consider building your stock portfolio once your savings become Rs 4-5 lakh. There are two key advantages of it. One is that once you invest in an equity fund and do your SIP, you will get used to or you'll get an opportunity to acclimatise yourself with the equity market because markets are crazy. And that is why they have proved to be rewarding, but most people are unable to derive the benefit out of it. So you will partially get used to it. Also, use this two-three years period, in which you will be doing your SIP, to develop a temperament and develop an expertise - how to look at a company, what works in investing, what does not work in investing - because investing has become very easy. That doesn't really mean it's a very easy way to make money from investment. You can very easily lose money if you're not careful about it, if you're not doing it thoughtfully. So it will give you an opportunity to step back and experience it and develop your framework of how to think when investing in shares.

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