Smart Beta ETFs vs Passive ETFs: Key Differences & Which One to Choose?
Over the years, many investors have gravitated towards passive investing with exchange-traded funds (ETFs). ETFs are a cost-effective way to diversify and gain broader market exposure without picking up individual stocks. That said, investors often question whether they should opt for smart beta exchange-traded funds or passive ETFs. Though both are ETFs, they are different from each other.
What are Passive ETFs?
Passive ETFs track a market index and aim to replicate the index's performance. Holding the securities in the same proportion, passive ETFs have lower expense ratios. Passive ETFs are easy to understand as they aim to replicate the index's performance.
What are Smart Beta ETFs?
Smart beta exchange-traded funds combine the elements of active and passive investing. While smart beta ETFs' investment style is active, their investment philosophy is passive. For example, a smart beta ETF tracking the Nifty 50 will not have all the index stocks. However, it will only have stocks that satisfy certain factors such as revenue, growth and volatility, among others.
Passive ETFs and Smart Beta ETFs: Key Differences
Passive ETFs and smart beta funds differ on several aspects (see table):
| Aspects | Passive ETFs | Smart Beta ETFs |
|---|---|---|
Strategy | They track an index and follow purely passive strategy | Combines active and passive investment style following specific factors |
Cost | Entail lower costs as they follow only passive strategy | With ingredient of active investing, it entails higher cost |
Risk adjusted Returns | May lag behind the market | They have the potential to offer better risk adjusted returns |
Simplicity | Simple and transparent | They are relatively more complex |
What Should You Opt For?
While passive ETFs and smart beta ETFs can help you with passive investments, the choice depends on individual preferences. You can opt for passive ETFs if:
- You want a low-cost investment option that requires little effort to monitor a portfolio
- You need wide diversification without any guesswork
- You want simple, hands-off approach to investing
On the other hand, you can opt for smart beta ETFs if:
- You are willing to handle a little more complexity with your passive investment
- You aim for higher risk-adjusted returns and are willing to pay higher fees for it
- You want targeted exposure to specific factors like low volatility and customisation
Conclusion
Combining passive ETFs with smart beta ETFs can offer you the best of both worlds. They can help you create a balanced portfolio and lay the foundation for long-term growth. That said, the choice will depend on your personal goals, risk tolerance, and the time you are willing to invest in managing your investments.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.
Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Please read the SEBI-prescribed Combined Risk Disclosure Document before investing. Brokerage will not exceed SEBI’s prescribed limit.
