When it comes to U.S. stocks, the S&P 500 is the king of the index mountain. The measure of the 500 (OK, technically 502 thanks to multiple share classes) is widely regarded as the benchmark for the entire market. The S&P 500 covers approximately 80% of our country’s entire market cap.
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Given the breadth and size of the index, it’s no wonder why investors use it as a guide.
More than $7.8 trillion of investor money is benchmarked to the S&P 500. Of that hefty sum, $2.2 trillion is tied directly to the benchmark via index funds — with exchange-traded funds (ETFs) continuing to gobble up increasingly more of that cash.
The three biggest — the SPDR S&P 500 ETF (SPY), iShares Core S&P 500 ETF (IVV) and Vanguard 500 Index Fund (VOO) — hold more than $280 billion together. And there’s nothing wrong with holding any of the three funds. After all, just matching the market is a feat many hedge fund and mutual fund managers can’t tackle, so it doesn’t hurt to invest in one of these funds to get the S&P 500’s average return over the longer haul.
But that doesn’t mean you can’t try to beat the average, too.
A new breed of so-called “smart beta” ETFs use various screens and alternative weighting methods to track the venerable S&P 500 … with twists they believe will add overall value. In short, smart beta funds combine the benefits of low-cost indexing with the positives of active management.
So, if you’re looking for a “smarter” way to buy the S&P 500, these three funds are a great place to start.
Smart Beta S&P 500 ETFs: Guggenheim S&P 500 Equal Weight ETF (RSP)
One of the big issues with the S&P 500 is that it is market-cap-weighted. That means the larger stocks in the index carry more “oomph” than the smaller ones.
For example, if $734 billion tech giant Apple (AAPL) is having a good day or a bad day, it will affect the S&P 500’s performance a lot more than a move from, say, multi-line insurer Assurant (AIZ) — at $4.5 billion, it’s one of the smaller constituents of the S&P 500.
This market bias toward larger, slower-moving stocks can zap returns, as the smaller, faster-moving firms can’t really let their gains be heard.
However, by “equal weighting” the S&P 500 — in which all stocks have similar (though not exactly equal) weight — you can give the index’s smaller companies a chance to juice your returns.
The proof is in the pudding. The S&P 500 Equal-weight Index (EWI) has managed to beat the benchmark index by a full 2 percentage points each year for the past 10 years.
The Guggenheim S&P 500 Equal Weight ETF (RSP) tracks the aforementioned EWI, and weights all S&P 500 companies between 0.3% and 0.13%. Google (GOOG, GOOGL) and Discovery Communications (DISCK, DISCA) have smaller percentages, but spread across a pair of shares each.
This weighting has helped the RSP produce a market-beating 11.6% annual return since inception in 2003.
Expenses for RSP run just 0.4%, or $40 annually for every $10,000 invested — more expensive than the straight-up S&P 500 trackers, but still not enough to eat up the fund’s outperformance.
Smart-Beta S&P 500 ETFs: PowerShares S&P Low Volatility ETF (SPLV)
Another thing that can break a portfolio is volatility, as large valleys during bear markets can sometimes scare investors off too quickly before they can be made whole again.
However, so called “low-volatility” funds can help you smooth out the rougher times.
Enter the $4.7 billion PowerShares S&P Low Volatility ETF (SPLV) may be of use.
The SPLV tracks 100 stocks in the benchmark S&P 500 that have exhibited the lowest volatility over the past 12 months. Basically, it looks at the firms in the parent index that don’t jump around by as much. As such, current top holdings are waste collector Stericycle (SRCL) and Procter & Gamble (PG). And like RSP, this fund is equal-weighted.
SPLV has underperformed the SPY by about 40 basis points annually since its inception in 2011. However, we’ve also not experienced the kind of market environment that would make SPLV shine — namely, a bear market. That said, in 2014 — the S&P 500’s worst full year of performance since SPLV got up and running — SPLV recorded 17.3% gains to the S&P 500’s 13.7%.
Expenses for SPLV run a cheap 0.25%.
Smart-Beta S&P 500 ETFs: ProShares S&P 500 Dividend Aristocrats ETF (NOBL)
To paraphrase fellow InvestorPlace contributor Charles Sizemore: “Any stock that has proven its ability to maintain/raise its dividend over long stretches is a high-quality company.”
Well, a special subset of those high-quality companies — dubbed “Dividend Aristocrats” — have managed to increase their dividends for at least 25 consecutive years. The S&P 500 Dividend Aristocrats Index comprises those companies in the S&P 500 that have done such a feat, then equally weights them.
And the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) is the only ETF that tracks the Dividend Aristocrats.
Don’t let NOBL’s relatively small dividend yield of 2.04% fool you. NOBL is about dividend growth as a means of selecting high-quality companies — a methodology that translates into performance.
The Dividend Aristocrats have managed to outperform the bread-n-butter S&P 500 by a pretty decent margin. Over the past 10 years, the S&P’s Dividend Aristocrats have returned about 2 percentage points better annually, and with less volatility.
Expenses for NOBL are pretty cheap as well at just 0.35%.
As of this writing, Aaron Levitt was long RSP.
