Smart Beta Index : 1 year perspective

iFinStrats
1 minute ago
6 min read

Last year during this month of September all fin influencers were going gaga about Smart Beta Index

An in-depth analysis of Smart Beta index underperformance from September 2024 to September 2025

The period from September 2024 to September 2025 has been particularly challenging for Smart Beta indices in India, with every major factor-based index significantly underperforming the Nifty 50 benchmark. While the Nifty 50 managed a modest 0.19% return, Smart Beta indices posted losses ranging from -3.8% to -14.9%, raising important questions about factor investing effectiveness and timing.

The Great Smart Beta Underperformance of 2024-2025

Performance Snapshot

The underperformance has been widespread across all major Smart Beta strategies:

Nifty 200 Momentum 30: -14.9% (worst performer)
Nifty Alpha Low Volatility 30: -9.2%
Nifty Quality 30: -7.0%
Nifty 500 Value 50: -6.8%
Nifty High Beta 50: -3.9%
Nifty Alpha Quality Value Low Volatility 30: -3.8% (best among Smart Beta)
Nifty 50 Benchmark: +0.19%

This represents the most significant underperformance period for Smart Beta indices since their inception, with even multi-factor strategies failing to provide protection.

Individual Index Analysis

Nifty Alpha Low Volatility 30 Index

Current Composition :
Top Holdings: HDFC Bank (5%), TCS (5%), ICICI Bank (5%)
Sector Allocation: IT (30%), Banking (25%), FMCG (20%)
Rebalancing: Semi-annual (June & December)

Underperformance Reasons :
a. Defensive stocks severely lagged during the risk-on market environment
b. Low volatility factor fell completely out of favor as investors chased momentum
c. The index's defensive bias worked against it during market optimism
d. Banking sector weakness, particularly in private banks, hurt performance

Rebalancing Impact :
The December 2024 rebalancing had limited impact as the methodology continued to favor defensive, low-volatility stocks despite their underperformance. The index maintained its defensive characteristics, unable to adapt to the changing market regime.

Nifty 200 Momentum 30 Index

Current Composition :
Top Holdings: Zomato, PB Fintech, Indian Hotels
Sector Allocation: Consumer Discretionary (25%), IT (20%)
Rebalancing: Semi-annual (March & September)

Underperformance Reasons :
a. Classic momentum reversal: previous winners became significant laggards
b. Sector rotation away from high-momentum stocks in consumer discretionary
c. Growth stock valuations compressed significantly
d. The September 2024 rebalancing actually added to losing positions

Rebalancing Impact :
The September 2024 rebalancing proved counterproductive, adding exposure to stocks that had shown strong momentum but were about to reverse. This highlights the backward-looking nature of momentum indicators.

Nifty Quality 30 Index

Current Composition :
Top Holdings: TCS, Infosys, HDFC Bank, Asian Paints
Sector Allocation: IT (35%), Banking (25%), FMCG (15%)
Rebalancing: Semi-annual (March & September)

Underperformance Reasons :
a. Quality premium compression as expensive valuations became unsustainable
b. Growth stocks outperformed traditional quality metrics
c. High-quality stocks faced multiple contraction despite earnings stability
d. Sector concentration in IT and banking hurt performance

Rebalancing Impact : The September 2024 rebalancing maintained quality criteria, but market dynamics favored growth over quality, making the factor temporarily irrelevant.

Nifty 500 Value 50 Index

Current Composition :
Top Holdings: SBI, Hindalco, NTPC, Tata Motors
Sector Allocation: Banking (32%), Energy (16%), Metals (13%)
Rebalancing: Semi-annual (March & September)

Underperformance Reasons :
a. Classic value trap scenario in cyclical sectors
b. Banking sector (especially PSU banks) faced headwinds
c. Metal and energy sectors remained weak despite value appeal
d. Economic growth concerns affected cyclical value plays

Rebalancing Impact : The rebalancing process actually increased exposure to underperforming sectors, demonstrating how systematic value approaches can amplify sector-specific risks.

Nifty Alpha Quality Value Low Volatility 30 Index

Current Composition :
Top Holdings: HDFC Bank (15.5%), TCS (11.9%), ICICI Bank (10.5%)
Sector Allocation: IT (28%), Banking (26%), FMCG (17%)
Rebalancing: Quarterly

Underperformance Reasons :
a. Multi-factor dilution reduced effectiveness of any single factor
b. Complex factor interactions worked against each other
c. No single factor provided positive contribution
d. Higher rebalancing frequency increased transaction costs

Rebalancing Impact : Despite quarterly rebalancing providing more frequent adjustments, the multi-factor approach couldn't overcome the systematic headwinds facing all underlying factors.

Nifty High Beta 50 Index

Current Composition :
Focus on high-beta, volatile stocks across sectors
Rebalancing: Semi-annual

Underperformance Reasons :
a. High beta stocks faced selling pressure during uncertainty periods
b. Risk-off sentiment in certain market phases hurt volatile stocks
c. Investors preferred stability over volatility despite risk-on environment

Rebalancing Impact : Despite quarterly rebalancing providing more frequent adjustments, the multi-factor approach couldn't overcome the systematic headwinds facing all underlying factors.

Why Rebalancing Doesn't Always Prevent Underperformance

The Fundamental Limitations

Market Environment Override Rebalancing maintains factor exposure even when the entire factor is out of favor. In 2024-2025, defensive factors like low volatility and quality were systematically disadvantaged by the market environment.
Backward-Looking Nature Factor selection is based on historical data, which may not predict future performance. The September 2024 rebalancing selected stocks based on past momentum, quality, or value metrics that proved ineffective going forward.
Composition Lag New stocks added during rebalancing may continue the same underperformance trends that affected previous holdings, as seen in momentum and value indices.
Transaction Costs Frequent rebalancing increases costs, reducing net returns, particularly evident in the quarterly-rebalanced multi-factor index.
Style Persistence Systematic biases in factor construction persist through rebalances, preventing adaptation to new market dynamics.
Sector Concentration Risk Factor-based selection often leads to sector concentration, amplifying sector-specific risks during rebalancing.

Market Environment Analysis: When Smart Beta Works vs. Fails

Current Unfavorable Environment (2024-2025)

Risk-on sentiment: Favored growth over defensive qualities
Momentum reversal: Previous winners became laggards
Valuation compression: Quality and growth premiums disappeared
Sector rotation: Systematic shifts away from factor-concentrated sectors
Economic uncertainty: Created mixed signals for value and quality factors

Historical Outperformance Periods

Smart Beta indices have historically outperformed during:

Market corrections and high volatility periods (2008, 2020)
Sideways or range-bound markets (2011-2013)
Economic transition periods with clear factor advantages
Periods of sustained trends favoring specific factors

Investment Strategy Recommendations

Nifty Alpha Low Volatility 30
Current Strategy: Continue SIP
Rationale: Defensive nature provides portfolio stability
Optimal Environment: Market corrections >15%, VIX >25
Portfolio Allocation: 15-25% (Core defensive holding)

Nifty 200 Momentum 30
Current Strategy: Pause SIP
Rationale: Wait for clear momentum reversal signals
Optimal Environment: Sustained market trends >6 months
Portfolio Allocation: 0-10% (Tactical only)

Nifty Quality 30
Current Strategy: Continue SIP
Rationale: Quality remains relevant long-term despite cyclical headwinds
Optimal Environment: Earnings growth acceleration periods
Portfolio Allocation: 10-20% (Core quality exposure)

Nifty 500 Value 50
Current Strategy: Gradual lumpsum investment
Rationale: Value opportunities emerging but timing uncertain
Optimal Environment: Economic recovery with interest rate cuts
Portfolio Allocation: 10-15% (Value opportunity)

Multi-Factor Indices
Current Strategy: Continue SIP
Rationale: Diversified factor exposure reduces single-factor risk
Optimal Environment: Range-bound markets with factor rotation
Portfolio Allocation: 5-15% (Diversification)

Nifty High Beta 50
Current Strategy: Tactical allocation only
Rationale: High risk requires precise timing
Optimal Environment: Bull market confirmation with risk appetite return
Portfolio Allocation: 0-5% (Tactical high-risk)

When to Expect Outperformance Revival

Short-term Catalysts (6-12 months)

Market correction >10% favoring defensive factors
Clear economic recovery signals benefiting value factors
Sustained earnings growth supporting quality factors
Momentum reversal in favor of previously lagging sectors

Medium-term Factors (1-3 years)

Economic cycle turning points
Interest rate cycle changes
Sector rotation completing full cycles
Factor performance mean reversion

Long-term Structural Changes (3+ years)

New market regimes favoring specific factors
Regulatory changes affecting factor effectiveness
Technological disruption creating new factor dynamics

Key Takeaways for Investors

Factor Timing is Crucial but Difficult The 2024-2025 period demonstrates that even well-constructed factor indices can underperform significantly when market conditions are unfavorable. Timing factor rotation is as challenging as timing individual stocks.
Rebalancing is Not a Panacea Systematic rebalancing cannot overcome unfavorable market environments for specific factors. It may even amplify underperformance by maintaining exposure to out-of-favor characteristics.
Long-term Perspective Essential Despite recent underperformance, Smart Beta indices have delivered superior risk-adjusted returns over longer periods. The current period should be viewed as part of natural factor cycles.
Diversification Across Factors Multi-factor approaches provide some protection but cannot eliminate factor-specific risks entirely. True diversification requires combining factor indices with traditional market-cap-weighted indices.
Cost Considerations Higher expense ratios and tracking errors in Smart Beta funds can erode returns, particularly during underperformance periods. Cost-conscious selection becomes more critical.

Conclusion

The widespread underperformance of Smart Beta indices from September 2024 to September 2025 serves as a crucial reminder that factor investing, despite its systematic approach, remains subject to market cycles and timing risks. While rebalancing helps maintain factor exposure and reduces concentration risks, it cannot overcome fundamental shifts in market preferences and economic conditions.

Investors should view this period as part of the natural ebb and flow of factor performance rather than a failure of the Smart Beta approach. The key is maintaining appropriate portfolio allocations, continuing systematic investment approaches where fundamentally sound, and preparing for the eventual factor rotation that history suggests is inevitable.

The current environment may actually present opportunities for patient investors to accumulate positions in temporarily out-of-favor factors at attractive valuations, positioning for the next cycle of outperformance when market conditions become more favorable to systematic factor strategies.

This analysis is based on market data and performance figures from September 2024 to September 2025. Past performance does not guarantee future results, and investors should consider their risk tolerance and investment objectives before making investment decisions.