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Smart beta vs traditional large-caps: Which passive index should you pick?
Source: Live Mint
A lot has been discussed about active versus passive mutual funds, and how to choose between their categories. With many active funds, especially large-cap ones, struggling to consistently outperform their benchmarks, investors are increasingly turning their attention to passive funds.
But did you know that within the passive large-cap space—the top 100 companies by market capitalization, as per the Securities and Exchange Board of India (SEBI)—there are multiple types of passive indices for investors to choose from?
On the traditional side, we have considered three indices: BSE Sensex, Nifty 50, and Nifty 100. On the smart beta side, there are eight options: Nifty 100 Alpha 30, Nifty 100 Low Volatility 30, Nifty 100 Quality 30, Nifty 100 Equal Weight, Nifty 50 Equal Weight, Nifty Next 50, Nifty 50 Value 20, and Nifty Top 10 Equal Weight.
It can get confusing, right? Should you choose the large-cap traditional indices or smart beta indices—or both? Each of these 11 large-cap indices follows unique strategies. Based on a 10-year daily rolling compound annual growth rate (CAGR) returns from 1 April 2015 to 30 August 2024, the average returns generated by the traditional large-cap indices have been 12-12.5%, with maximum returns ranging between 17.6-18.3% CAGR and minimum at 5.1-5.6%.
On the other hand, large-cap smart beta indices have delivered average returns of 11.4-15.9% CAGR, with maximum returns ranging from 16.3-24.3% and minimum returns between 2.7-9.4% CAGR. This clearly shows that large-cap smart beta indices have often outperformed their traditional counterparts.
While certain large-cap smart beta indices can be more volatile and exhibit cyclical behavior compared to traditional large-cap indices, they have proven their outperformance strength at the minimum, maximum, and average levels over the long run.
To dive deeper into the performance difference between traditional and smart beta indices, let’s look at the percentage of time each category has generated returns greater than or equal to 15% CAGR. From 1 April 2015 to 30 August 2024, large-cap smart beta indices have delivered returns of 15% or more in 51-66% of instances, while traditional indices have managed this level only 11-16% of the time. This clearly indicates that large-cap smart beta indices have outperformed traditional large-cap indices in terms of generating higher returns more frequently.
Among the large-cap smart beta indices, Nifty 100 Alpha 30, Nifty 100 Low Volatility 30, Nifty Next 50, and Nifty 50 Value 20 have stood out as clear winners in terms of delivering superior risk-adjusted returns, outperformance, and consistency compared to the others.
Now, how should investors choose between these large-cap smart beta indices? The answer is simple. If your portfolio is skewed toward a growth style, choosing a value index like Nifty 50 Value 20 can help balance it. Conversely, if your portfolio leans toward value, opting for a growth index like Nifty 100 Alpha 30 or Nifty Next 50 can be beneficial.
Looking at the data, Nifty 100 Low Volatility 30 appears to offer a sweet spot. It has delivered an average of 15.7% CAGR returns over a 10-year daily rolling period, which is on par with the other leading indices. It has also achieved greater than or equal to 12% CAGR returns more frequently than the others and has a higher 10-year minimum return of 9.4% CAGR—better than its peers. With lower volatility and better consistency, Nifty 100 Low Volatility 30 can be a good blend of growth and value for investors.
Does this mean traditional large-cap indices are no longer relevant? Absolutely not. Traditional large-cap indices are simple, plain-vanilla options that reduce the complexity of product selection, help keep portfolios simple, and make it easier to understand market dynamics. They also generate returns that align closely with market performance.
Smart beta indices, while capable of delivering superior returns, can be more volatile and cyclical, and may underperform at times. For investors who do not fully understand the complexities of the smart beta space, sticking with traditional indices might be the safer choice. Regardless of the type of passive index chosen, it’s important to select a passive fund with a lower expense ratio and tracking error, as this will help achieve returns closer to the respective index.
—Rushabh Desai, founder, Rupee With Rushabh Investment Services
