Smart Beta ETFs: How are they different from traditional ETFs?

Smart Beta ETFs are ETFs that track the performance of an index that is not necessarily market-cap-weighted or weighted by conventional metrics. Smart Beta ETFs can be considered as an intelligent version of passive investment products. These are factored indices, where a fund manager follows an index based on certain sacrosanct rules.

Prateek Mehta, Co-Founder and CBO, Scripbox, says, “These indices could be based on factors that are qualitative in nature, but can be applied to component selection and portfolio construction using quantitative or rule-based models.”

Smart Beta ETFs bring in the advantages of both passive and active management by combining both into a single model.

Amit Dhakad, CEO and CTO of market Pulse Technologies, says, “Smart Beta ETFs are a combination of active and passive investing with an enhanced indexing strategy. It is a rule-based systematic approach to choose companies with specific metrics.”

With smart beta ETFs, the combination of active and passive style where the investment philosophy remains passive, but the investment style becomes rule-based, hence, active. Nitin Kabadi, Head- ETF Business, ICICI Prudential AMC says, “This feature separates it from other traditional ETF offerings, making it an interesting proposition for those investors who otherwise consider index fund or ETF to be boring.”

Unlike traditional ETFs which blindly track an index, smart beta ETFs are based on customized indexes with one or more predetermined factors. They are aimed at enhancing returns and reducing risk as compared to traditional capitalization-weighted benchmark ETFs.

Currently, the large-cap category based ETFs dominate the ETF universe. Kabadi, of ICICI Prudential AMC, says “With the improvement in market understanding, there could be an increase in investments in the ETFs tracking midcap and small-cap segment as well, similar to other developed markets like the US and Europe.”

Having said that, industry experts say while this is a promising space and is evolving quite fast, the universe of investable smart beta products is still quite restrictive in India.