One of the biggest recent trends in investing has been the surge in exchange-traded products employing smart-beta strategies. But one money manager says smart beta is phooey, and he’s developed an alternative strategy he posits can deliver better results with less risk.

Vikas Gupta, chief investment officer at ArthVeda Capital, has created a suite of Smart Alpha indexes that employ a rules-based methodology he says takes the value investing philosophy and principles of Benjamin Graham and Warren Buffett to the next level. 

Smart beta, also known as strategic beta, takes many forms but essentially follows rules-based indexes providing exposure to specific factors, market segments or systematic strategies other than market-cap weighting. These mostly apply to equities.

Smart alpha, on the other hand, is built on three core principles: taking less risk and, therefore, losing less capital compared to the markets; focusing on companies that generate high returns on their invested capital; and paying less than the intrinsic value and locking in a source of risk-free profits. 

“The concept behind smart beta is that there are specific risk factors for which the market is willing to compensate investors who take on those risks with a premium over and above the market returns,” Gupta says. “Thus, it is often a high risk/high return strategy. We completely disagree with this concept and think that this is a distorted idea of how risk and returns work. In our opinion, risk is what makes one lose money and not something that generates higher returns. Therefore, we believe that avoidance of risk will ultimately lead to better performance.”

Gupta opines that smart-beta strategies based on price-related factors such as volatility and momentum, or various fundamentals such as sales, book value or earnings, don’t address true company and market risks. 

“We think risks are specific—as in risk of default,” Gupta says. “This is something investors need to avoid, and a company with no leverage cannot go bankrupt. There is a very clear idea of risk related to leverage and ability to pay interest from earnings. Smart alpha focuses on avoiding or mitigating these kinds of risks.” 

Gupta has created eight indexes under the Smart Alpha umbrella, and they fall under three categories: Smart Alpha, Smart Value and Smart Income. Each index component is weighted by its discount to intrinsic value as determined by ArthVeda’s proprietary model, and indexes are rebalanced quarterly. 

The Smart Alpha category focuses on four major risk factors: business risk, financial risk, capital allocation risk and price risk. Smart Value indexes focus on the price risk and don’t consider the business risk or financial risk independently. And Smart Income indexes consist of the top 50 dividend-paying companies that remain after ArthVeda removes companies that are riskier, according to its criteria. 

Based in India, ArthVeda (“Arth” is Sanskrit for “wealth,” while “Veda” means “knowledge” or “wisdom”) is an asset management firm that previously focused on alternative investment funds aimed at ultra-high-net-worth and institutional investors. Gupta says the firm is branching out to launch European UCITS funds (it stands for “undertakings for collective investments in transferable securities,”) as well as provide sub-advisory services to registered investment advisors and investment managers worldwide. 

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