The Best Smart Beta ETFs You Should Know Now

It was too late. John had already missed out on the best performing smart beta ETFs of the year, and by the time he realized it, the market had moved on. But what if you could avoid his mistake? What if you had known exactly which ETFs were likely to outperform? That’s the appeal of smart beta ETFs, a type of investment strategy that seeks to combine the best of both worlds: the diversification of index investing with the potential for outperformance of actively managed funds.

So, what are smart beta ETFs? They are ETFs that use alternative index construction rules to traditional market-cap-weighted ETFs. Instead of simply buying the largest companies by market value, smart beta strategies aim to improve returns, reduce risk, or enhance diversification by selecting stocks based on factors like value, momentum, low volatility, or dividends.

Why Should You Care About Smart Beta?

The appeal of smart beta ETFs lies in their potential to exploit proven investment factors, like value (buying cheap stocks) or momentum (buying stocks that are rising). Historically, these factors have been shown to provide excess returns over the long term. But, unlike actively managed funds, smart beta ETFs are usually lower in cost, making them an appealing option for investors who want to try and beat the market without paying high fees.

John’s regret was that he didn’t know which smart beta ETFs to choose. There are hundreds out there, and not all are created equal. Some outperform, while others do little more than track the market.

But you’re not John. By the end of this article, you’ll know exactly which smart beta ETFs are performing well now, which factors they focus on, and how they might fit into your portfolio.

Top Smart Beta ETFs in 2024

Let’s dive into some of the best-performing smart beta ETFs right now. These funds are using factors like low volatility, dividend yield, and momentum to try and outperform traditional index funds.

1. iShares Edge MSCI Min Vol USA ETF (USMV)
   USMV is designed to provide exposure to U.S. companies that have exhibited lower volatility than the broader U.S. equity market. It’s a great option for investors looking to reduce risk without sacrificing too much in potential returns.

   • Factor: Low Volatility
   • YTD Return: 8.6%
   • Expense Ratio: 0.15%

2. Vanguard Value ETF (VTV)
   This ETF aims to track the CRSP US Large Cap Value Index, which includes stocks that have strong fundamentals like low price-to-earnings ratios. Value stocks tend to outperform during periods of market recovery, making this ETF a solid pick for long-term investors.

   • Factor: Value
   • YTD Return: 12.3%
   • Expense Ratio: 0.04%

3. Invesco S&P 500 High Dividend Low Volatility ETF (SPHD)
   SPHD focuses on 50 of the least volatile high-dividend-yielding stocks in the S&P 500 Index. This combination of income generation and low volatility makes it an attractive option for conservative investors seeking steady returns.

   • Factor: Dividend Yield, Low Volatility
   • YTD Return: 5.1%
   • Expense Ratio: 0.30%

Understanding the Risks and Rewards

Investing in smart beta ETFs is not without its risks. While these funds aim to outperform traditional index ETFs, there’s no guarantee that they will. Factor investing can be cyclical. For example, momentum strategies tend to do well when markets are trending strongly in one direction, but they can underperform during sideways or choppy markets. Similarly, value strategies may lag during periods of market exuberance when high-growth stocks are in favor.

Another key risk is that not all smart beta ETFs are created equal. Some funds have higher turnover, which can lead to higher transaction costs and tax implications. Others might focus on factors that simply don’t perform well in the current market environment.

However, for investors willing to do their homework, smart beta ETFs can be an effective way to potentially enhance returns or reduce risk in a diversified portfolio.

How to Choose the Right Smart Beta ETF

John’s mistake was failing to understand that not all smart beta ETFs are right for every investor. Before you invest, it’s essential to determine your own financial goals and risk tolerance.

Here’s a quick guide on how to choose the right smart beta ETF:

1. Identify Your Factor: Do you want to focus on value, momentum, dividends, or low volatility? Each of these factors performs differently in various market conditions, so it’s crucial to pick the one that aligns with your investment strategy.

2. Look at the Expense Ratio: One of the key advantages of ETFs is their low cost, but some smart beta ETFs have higher fees than traditional index ETFs. Make sure the potential outperformance justifies the higher cost.

3. Review Historical Performance: While past performance is not indicative of future results, it can provide insight into how a particular factor has performed over time. Some factors, like value and momentum, have decades of academic research supporting them.

4. Consider the Market Environment: Different factors perform better in different market conditions. For example, low volatility ETFs tend to do well in bear markets, while momentum ETFs may perform better in strong bull markets.

5. Diversification: Even though smart beta ETFs are designed to outperform, they should still be part of a diversified portfolio. Avoid putting all your money into a single factor or ETF.

The Bottom Line: Smart Beta for a Smarter Portfolio

John’s story serves as a cautionary tale, but you can avoid his mistakes by understanding the different types of smart beta ETFs available and how they can fit into your investment strategy. Whether you’re looking to reduce risk, generate income, or try to beat the market, there’s likely a smart beta ETF out there that aligns with your goals.

By focusing on factors like low volatility, dividends, or value, you can potentially enhance your returns without taking on excessive risk. Just remember, no strategy is foolproof, and it’s important to regularly review your portfolio to ensure that your investments continue to align with your financial objectives.

If you learn one thing from John’s story, let it be this: The best time to invest in a smart beta ETF is before the crowd catches on, not after. So, what are you waiting for?