Smart-Beta Funds: A New Approach to Index Investing
A new category of investment funds is transforming the landscape of passive investing in India. Known as smart-beta funds, these products aim to combine the cost-efficiency of passive investing with the strategic elements typically associated with active fund management. Unlike traditional index funds that simply mirror market capitalization-weighted indices, smart-beta funds track indices based on specific rules linked to investment factors such as value, momentum, quality, alpha, or low volatility.
Performance Analysis: Which Factors Delivered in 2025?
The year 2025 has demonstrated that not all smart-beta strategies perform equally. According to data as of 31 October 2025, the value and low volatility factors have emerged as clear outperformers. The Nifty 500 Value 50 Index surged 14.04% year-to-date, while the Nifty 500 Low Volatility 50 Index delivered comparable gains of 14%. Both significantly outpaced the Nifty 500 Index, which rose approximately 7% during the same period.
In contrast, defensive factors like equal-weight and quality have posted positive returns but lagged behind the broader market. The momentum factor, represented by the Nifty 500 Momentum 50 Index, has been the worst performer, declining roughly 7% year-to-date.
Siddharth Srivastava, head ETF-product and fund manager at Mirae Asset Mutual Fund, explained this divergence: "Trend-driven factors such as momentum and alpha tend to underperform in a sideways market like the one we're seeing now. In contrast, low volatility or large-cap-heavy equal-weighted strategies tend to hold up better in such phases."
Understanding Sectoral Tilts and Factor Cyclicality
When selecting smart-beta funds, investors need to look beyond the factor itself and examine the underlying sector exposures. Kavitha Menon, founder of Probitus Wealth, emphasized: "When considering smart-beta or factor funds, investors should not just look at the factor, but also look at the sectors and the universe of stocks the factor is sticking to."
The value factor's strong performance in 2025 can be largely attributed to its significant exposure to PSU and commodity-linked stocks, which have benefited from robust earnings, government infrastructure spending, and firm commodity prices. Meanwhile, the low-volatility factor's resilience stems from its higher allocation to defensive sectors like FMCG and healthcare, which typically experience smaller declines during market turbulence.
The quality factor, which focuses on companies with strong balance sheets and consistent earnings, has underperformed due to its substantial exposure to IT stocks that have struggled recently. Momentum strategies, typically weighted toward mid-cap and small-cap stocks, have suffered because these segments are more vulnerable to sentiment shifts in consolidating markets.
Strategic Implementation: Diversification is Key
Given the cyclical nature of factor performance, financial experts caution against relying on a single smart-beta strategy. Bhavesh Jain, co-head of factor investing at Edelweiss Mutual Fund, noted the difficulty in predicting which factor will outperform at any given time due to rapidly changing market dynamics.
The solution lies in diversification. Srivastava recommended: "Investors that understand the cyclicality of smart-beta strategies and sectoral tilts may consider them as these can go through periods of underperformance. For other investors, opting for multi-factor strategy is a better option as factors with opposing tendencies can complement each other."
Combining complementary styles—such as momentum with low volatility or value with quality—can help balance the risk-return profile. Menon suggested studying long-term performance metrics including historical rolling returns, volatility, and Sharpe ratios to identify effective combinations.
Smart-beta funds are best utilized as supplementary diversification tools or tactical investments rather than core portfolio replacements. They represent a sophisticated approach to investing that requires understanding how different factors interact across market cycles. For investors who have already established a solid foundation with traditional mutual funds, smart-beta strategies can provide an additional layer of strategic exposure to potentially enhance portfolio returns while managing risk.
