Smart-Beta Value Funds Surge: PSU Impact, Not True Value
Financial professional observes market performance data on a digital display in an Indian investment firm.
Key Highlights
Indian smart-beta value funds saw a recent surge, but it was driven by PSUs, not a core value investing shift. Cautious allocation (5-10% of equity) is advised.
Indian smart-beta index funds, specifically those focused on value, have recently experienced a significant turnaround in performance. This reversal over the last two years was largely fueled by the robust showing of Sector Undertakings (PSUs) heavily represented within these indices.
Unlike traditional market-capitalization-weighted indices, smart-beta funds employ rule-based factors such as value, momentum, quality, or low volatility for stock selection and weighting. Historically, several value-factor smart-beta indices in India had lagged the broader market.
PSU Concentration Drives ‘Value’ Gains
The recent sharp reversal in these value-factor funds, observed over the last two years, directly correlates with the strong performance of PSUs. This indicates that the gains stemmed from sector-specific strength rather than a fundamental validation of the ‘value’ investing style itself.
- Value-factor smart-beta indices had previously underperformed the broader market.
- Their recent turnaround is primarily attributed to strong Public Sector Undertaking performance.
- The concentration of PSUs within these indices was a key driver of returns.
Strategic Allocation for Smart- Funds
Investors considering these smart-beta funds must understand the underlying holdings and the actual drivers of returns, moving beyond just the factor label. Value Research suggests a conservative approach to allocation.
- Start with 5-10 percent of an equity portfolio for conservative investors.
- Do not exceed 20 percent of the equity portfolio, even for aggressive investors.
- Avoid chasing factors that have recently performed well, as factor performance tends to rotate unpredictably.
Aligning the chosen factor with an investor’s temperament is crucial for long-term success. Different factors suit different risk appetites and investment horizons.
- Aggressive investors might consider momentum-based indices.
- Moderate-risk investors could prefer low-volatility or quality indices.
Dhirendra Kumar of Value Research expressed caution in 2021 regarding these funds due to their limited live track records. The recent PSU-driven ‘value’ reversal reinforces the ongoing challenge of distinguishing genuine factor premia from sector-specific coincidences.
Understanding these dynamics is vital for investors aiming to integrate smart-beta strategies into their portfolios effectively. The true efficacy of a factor must be evaluated beyond short-term, sector-specific rallies.