Tracking Smart Beta indices during different market phases: A “smarter” option for passive investors?

Abstract

Purpose This study aims to examine whether tracking Smart Beta (SB) indices during bullish, bearish and stagnant market phases is a better choice for passive investors compared to Cap-Weighted (CW) indices. As investors’ strategies differ with market movements, this study analyses how single-factor and multi-factor SB indices perform during different market phases, in relation to CW indices. It also attempts to determine which SB factors are more suitable for investors in these phases. Design/methodology/approach Using various return and risk indicators, this study analyses how SB indices perform vis-à-vis CW indices during bullish, bearish and stagnant phases. The authors also evaluate the upside and downside participation advantage of SB indices and assess their ability to capture upside returns and limit downside risk. The authors attempt to determine the cyclical or defensive nature of SB indices using Average Participation values. Findings This study found that SB indices outperform CW indices during the bearish and stagnant phases. Multi-factor SB indices have lower risk levels in all market phases, providing downside protection to risk-averse investors. Dividend, Low Volatility, Quality and multi-factor SB indices are defensive portfolios offering better payoffs during the down market phases, while Alpha, Beta, Equal Weight and Value SB indices provide higher payoffs during the up-market phases. Originality/value To the best of the authors’ knowledge, this is the first study that examines the performance of single-factor and multi-factor Indian SB indices in different market phases. It determines the suitability of various factors to passive investors during these phases and also identifies whether SB indices are cyclical or defensive.