Investment Management

Smart Beta Index Investing

The Rise of Smart Beta Index Funds Among Family Offices and UHNIs

As the investment landscape becomes increasingly complex, family offices and ultra-high-net-worth individuals (UHNIs) are shifting their focus toward index funds and smart beta strategies. This transition reflects a broader trend in asset management, where cost efficiency, performance, and risk management take centre stage.

The Case for Cost Efficiency

Active Management Under Pressure

One of the primary drivers behind this shift is cost efficiency. Active fund management often incurs hefty fees that can erode returns over time. A significant number of actively managed funds have struggled to keep pace with their benchmarks. For instance, over half of Indian equity large-cap funds have underperformed the S&P BSE 100, with 52% lagging behind. Globally, around 66% of actively managed funds fail to outperform their respective indices over the long term source: SPIVA Report.

The latest SPIVA report for India reveals that over a five-year horizon, nearly 85% of active equity funds underperformed their benchmarks, emphasizing the challenges faced by active managers in consistently delivering superior returns.

Smart Beta as a Solution

In contrast, smart beta funds blend the best of both worlds—active and passive management—at a fraction of the cost. They allow family offices to pursue alpha generation without breaking the bank, making them an attractive option in today’s market.

Enhanced Risk-Adjusted Returns

The Power of Factor-Based Strategies

Smart beta strategies focus on specific factors such as value, momentum, low volatility, and quality. These strategies enable family offices to enhance their portfolios' performance without taking on excessive risk. For example, the NIFTY200 Momentum 30 index and the Nifty 100 Alpha Low vol Index have demonstrated higher returns compared to traditional indices like the NIFTY 50 while maintaining a stable risk profile. These strategies are particularly appealing in volatile markets where traditional active management may falter.

Index	3 year			1 year
Index	Rolling Return	Volatility (Std Dev)	Sharpe Ratio (Rf=6.745%)	Rolling Return	Volatility (Std Dev)	Sharpe Ratio (Rf=6.656%)
NIFTY 50	11.17%	6.76%	0.65	15.22%	23.29%	0.37
NIFTY NEXT 50	13.11%	9.38%	0.68	19.30%	34.14%	0.37
NIFTY 100	11.43%	6.84%	0.68	15.68%	24.37%	0.37
NIFTY200 MOMENTUM 30	17.18%	9.05%	1.15	22.92%	28.56%	0.57
NIFTY100 LOW VOLATILITY 30	13.93%	5.97%	1.20	17.48%	22.24%	0.49
NIFTY ALPHA 50	17.04%	14.00%	0.73	25.44%	38.49%	0.49
NIFTY ALPHA LOW-VOLATILITY 30	15.96%	7.99%	1.15	20.18%	23.40%	0.58

Rolling performance as of October 14, 2024. April 01, 2005 to October 14, 2024. Risk Free Rate Rf – 3 year and 1 year govt bond yield as on October 14, 2024

Diversification Benefits

A Safety Net for Large Portfolios

Smart beta funds also offer a level of diversification that is hard to achieve through active management alone. By adhering to predefined rules for stock selection and weighting, these funds help mitigate concentration risk often associated with market-cap-weighted indices. In India, smart beta index funds assets for 51 such ETFs and Funds have surged from less than ₹1,000 crores in 2021 to nearly ₹31,000 crores as of October 2024. Source:AMCs AUM Data/AceMF

Complementing Active Management

A Strategic Hybrid Approach

While many family offices still allocate substantial portions of their assets to actively managed funds, they increasingly see smart beta as a complementary strategy rather than a replacement. Santosh Singh from Mirae Asset Investment Managers explains that “smart beta can target specific risk-return profiles that traditional active or passive funds may miss” source: Financial Express.

This hybrid approach offers:

Flexibility: Family offices can adapt their exposure based on market conditions while benefiting from both active insights and passive strategies.
Transparency: Smart beta funds follow clear rules for stock selection, making it easier for investors to grasp the rationale behind their holdings compared to often opaque active management strategies.
Consistency: With fixed criteria for stock selection, smart beta funds can provide more stable performance metrics over time compared to the variability associated with different active managers.

Global Trends: A Broader Perspective

The Shift Towards Factor-Based Investing

The global landscape for smart beta investing is equally compelling. According to the SPIVA Global report, about 84% of actively managed global equity funds failed to beat their benchmarks in 2023 source: SPIVA Global Report. This trend underscores ongoing challenges faced by active managers across various regions.

In the U.S., smart beta ETFs have gained significant traction; new launches accounted for roughly a third of all ETFs introduced in recent years source: ETF Trends. The popularity is driven by a desire for better portfolio risk management and diversification along factor dimensions.

By integrating index funds and smart beta strategies into their portfolios, family offices can optimize asset allocation while maintaining the flexibility needed to adapt to changing market conditions. Embracing these innovative investment vehicles may just be the key to unlocking greater financial success in today's dynamic market environment.

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