Smart Beta Investing, Your Alpha Strategy!

Updated: Oct 25, 2018

When the writing on the wall is clear, smart folks try to read between the lines, interpret it early and take advantage. Remember, being smart mostly means catching the trend early, not creating the trend. Creation comes from the rare genre – genius, like Steve Jobs.

Presenting some of the trends in Wealth Management/Financial Advisory. The scopes of these trends are strictly confined to Investing/Investment Management. As a smart folk, you can catch these trends early and take advantage.

A) It will be difficult for Fund Managers to create sustainable high Alpha. For 2 reasons.

1. As the market becomes more efficient & matured, the spread narrows.

2. Post re-categorization the maneuverability has lowered considerably.

B) Advisor’s Alpha in the Total Portfolio, from Fund Selection is also likely to decrease due to Point A.

C) Asset Allocation & Investment Strategies from Advisory Firms will gain Prominence.

D) Indexing & Smart Beta will become main-stream.

It is the last point (point D) that we would want to focus your attention to.

1st, let’s look at Indexing.

Passive Investments carried out via Index Funds & ETFs are not very hot amid Advisor Community. While there could be many reasons for this phenomenon, what really intrigued us is the spread of this category vis a vis actively managed funds.

It’s a well- known fact that Advisors mostly do Index & not ETFs. But look at the options available. Hardly 5 unique indices out of which 4 are broad market based. To put this in perspective, let’s look at the Index Options available from NSE & BSE.

Now you see the dearth of options in Index Funds? It’s not the end of the story. You must have been already familiar with the Broad Market Indices & hence we would like your attention to Strategic Indices. A segment, we hope that is less explored. Before we get there, let’s spend a minute on Smart Beta.

It is a passive investment strategy that tracks the indices in which the weightage of the constituent stocks is not dependent on their market value. Such index is not constituted in the traditional manner. The relative weights of the stocks are based on some other factors which deliberately and decisively break the linkage between the market price and the weight in the index.

Smart betas have two distinct features:

1. They advocate against traditional market cap weighting, and

2. They are based on relatively transparent quantitative methodologies

Smart beta strategies usually fall into two camps: 1) heuristics based weighting strategies, which are based on simple and sensible rules, and 2) optimization based weighting strategies, which are complex and subject to problems with estimating returns and covariance.

Popular heuristics based weighting strategies include equal weighting, fundamentals weighting, risk clusters equal weighting, and diversity weighting.

Minimum volatility, maximum diversification, risk weighting etc. are the popular optimization based weighting strategies.

Back to Indexing

Let’s take a look at some of the Strategic Indices NSE is offering:

Now you see the dots? Smart Beta as an Investment Option is very much available from an Index Provider, but not yet come to Funds/ETFs. Globally there are more than 1000 ETFs that tracks Smart Beta Indices of which the AUM is above $ 1tn.

In India, we have 4 Strategic Indices available through are ETFs. Yes, just 4 that you can see the list below

The story will not be over unless we present how these Strategic Indices have performed and especially in relation to Nifty 50, BSE Sensex and some Fund Categories. And we assure you a thrilling climax.

CAGR: From 01-01-08 to 30-09-2018. All figures are in %

Connecting the Dots!

In this traumatic phase of Market Volatility, Revenue & Cost Pressure and Alpha Spread, here we are missing out on such low hanging opportunities of having a differentiated and cost effective investment strategy that has also proven very well in the past. Irony is, it’s not being offered a Fund/ETF yet.

But as the saying goes, “When the going gets tough, the tough gets going”, it’s time to take the onus of creating Investment Strategies at the Advisor Level. More so, if you claim to be a Robo-Advisor!

To help you get a perspective on execution, click the link below:

569 views2 comments