Smart Beta (or Factor Investing) describes index strategies that select and weight stocks by factors other than market cap — like value, momentum, quality, or low volatility.
Traditional index funds (like Nifty 50) weight stocks by market capitalisation — larger companies get bigger weights. Smart Beta challenges this by building indices based on fundamental or factor-based criteria: quality (high ROE, low debt), momentum (recent price outperformers), value (low P/B ratio), or low volatility (least volatile stocks). SEBI classifies smart beta funds within the passive fund category. Smart beta ETFs and index funds track these factor-based indices.
A regular Nifty 50 index gives more weight to whichever company is worth the most. Smart Beta says: 'Wait — let's pick stocks by quality, or by momentum, or by how cheap they are.' It's still passive (no individual stock picking) but the selection rule is a factor strategy rather than 'biggest company wins.' It sits between a pure index fund (totally passive) and an active fund (fund manager decides).
Index provider creates a factor-based index (e.g., Nifty 200 Quality 30, Nifty 100 Low Volatility 30, Nifty 500 Momentum 50).
AMC launches an ETF or index fund tracking this smart beta index.
Portfolio is still rules-based (no active management) but the rules are not market-cap weighting.
Expense ratios higher than plain vanilla index funds but lower than active funds.
Different factors outperform in different market cycles.