For many retail investors, laying a solid foundation for their portfolio starts with the basics: diversifying stock and bond holdings broadly, ensuring fees are minimal and keeping the overall investment approach straightforward.
It’s an age-old adage that simplicity can often yield the most favorable results. However, simplicity, while a commendable strategy, isn’t a panacea.
A case in point is the 60/40 portfolio — an allocation strategy that corresponds to a portfolio of 60% stocks and 40% bonds. This once-reliable mix recently faced one of its most challenging years since the 1930s due to the bond bear market.
In an era where positive stock-bond correlations are becoming more common, low-risk investors are now in search of alternative avenues to bolster their portfolios against unforeseen market dynamics.
Enter the realm of alternative exchange-traded funds, or ETFs, that go beyond the traditional approach. These “smart” ETFs employ sophisticated, rules-based methodologies — often reminiscent of those strategies utilized by hedge funds. Additionally, some of these ETFs hold derivatives, such as options, which are capable of managing risk further.
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The allure of these smart ETFs isn’t solely rooted in their advanced strategies. Unlike traditional hedge funds, these funds offer heightened accessibility, trading openly on exchanges just as stocks do.
Investors also benefit from heightened transparency, with these ETFs typically disclosing their holdings on a daily basis on the firm’s website.
But perhaps most enticing of all is the cost efficiency: Many of these smart ETFs charge fees that are substantially more reasonable than their hedge fund counterparts.
Here are six smart ETFs low-risk investors can buy in 2023:
| ETF | Expense Ratio |
| KFA Mount Lucas Managed Futures Index Strategy ETF (ticker: KMLM) | 0.90% |
| Invesco S&P 500 Low Volatility ETF (SPLV) | 0.25% |
| FT Cboe Vest U.S. Equity Buffer ETF — October (FOCT) | 0.85% |
| Innovator Equity Defined Protection ETF — 2 Yr to July 2025 (TJUL) | 0.79% |
| iShares iBonds Dec 2024 Term Treasury ETF (IBTE) | 0.07% |
| Invesco BulletShares 2024 Corporate Bond ETF (BSCO) | 0.10% |
KFA Mount Lucas Managed Futures Index Strategy ETF (KMLM)
KMLM is a unique alternative ETF benchmarked to the longstanding KFA MLM Index. This index tracks a portfolio of 22 futures contracts that cover 11 commodities, six currencies and five global bond markets weighted by their historical volatility, and follows trends by going either long or short on each. The goal of the ETF is to deliver positive absolute returns, while simultaneously ensuring a low correlation to traditional assets like stocks and bonds. The ETF currently charges a 0.90% expense ratio.
“KMLM was up 6.5% in the third quarter of 2023, and the strategy ended the quarter net long commodities, net short global fixed income and net long the USD to foreign currencies,” says Jerry Prior, chief operating officer, senior portfolio manager and managing partner at Mount Lucas Management. “The contributors to performance over the period were short positions in wheat, natural gas and corn, as well as a long position in sugar, coupled with gains from short global bonds and interest income.”
You might wonder how KMLM performed in 2022, when the 60/40 portfolio posted a 17% loss. The answer: KMLM handily achieved its goal of zigging when stocks and bonds zag and achieving a positive return, posting a 24.2% gain.
Invesco S&P 500 Low Volatility ETF (SPLV)
Investors looking for a different way to manage their equity allocation can use SPLV, which employs a screener to pick S&P 500 stocks with the lowest historical volatility. “SPLV selects the 100 stocks in the S&P 500 with the lowest one-year trailing standard deviation,” says Nick Kalivas, head of factor and core equity product strategy at Invesco. “Stocks are weighted by inverse volatility so that the stocks with the lowest volatility get the highest weight, and the process is repeated four times a year.”
SPLV’s current composition is heavily weighted toward three traditionally defensive sectors: consumer staples, utilities and health care at around 26%, 18% and 15%, respectively. “Lower volatility stocks should be consistent with companies with stable business conditions that are less subject to the ups and downs of the economic cycle and the ups and downs of the market itself, lending to more stable performance,” Kalivas says. The ETF charges a 0.25% expense ratio and pays a 2.4% 30-day SEC yield.
FT Cboe Vest U.S. Equity Buffer ETF — October (FOCT)
Investors keen on limiting their downside risk can consider “defined outcome” or “buffer” ETFs like FOCT. This ETF is based on the SPDR S&P 500 ETF (SPY) and uses an options strategy to eliminate the first 10% of potential losses from Oct. 23, 2023, to Oct. 18, 2024. In essence, if SPY fell by less than 10%, investors who purchased the ETF at the start of the period would not experience any losses. However, if the loss extends beyond 10%, FOCT will begin incurring losses again.
“Buffer ETFs help narrow the range of possible return outcomes for the index that it tracks,” says Mark Andraos, associate portfolio manager at Regency Wealth Management. “Think of them as ‘gutter guards’ when you went bowling as a child; the guard rails help keep you in a specified range.” The drawback of FOCT is that an investor’s upside return potential is also capped at 18% over the one-year period. The ETF also charges a fairly high 0.85% expense ratio.
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Innovator Equity Defined Protection ETF — 2 Yr to July 2025 (TJUL)
TJUL made headlines in July as the first defined outcome, or buffer, ETF to offer total downside protection against losses. This ETF seeks to track SPY while mitigating 100% of potential losses over a two-year outcome period from July 18, 2023, to June 30, 2025. In other words, an investor who purchased TJUL at the beginning of its outcome period can expect to incur no losses, assuming the ETF’s option strategy works as intended. TJUL charges a 0.79% expense ratio.
However, TJUL isn’t a free lunch. “The cost of paying for the downside protection is capped upside potential,” Andraos says. Investors who purchase TJUL will only be able to participate in up to 16.6% of SPY’s returns over the two-year period. “If you think the market is poised for a breakout and will rally significantly from its current levels, buffer ETFs may not be suitable as your upside potential will be capped to cover the cost of the downside protection,” Andraos says.
iShares iBonds Dec 2024 Term Treasury ETF (IBTE)
“As interest rates spiked over the last 18 months, investors in traditional bond ETFs suffered significant losses depending on the overall duration of the bond portfolio,” Andraos says. “Traditional bond ETFs are more exposed to interest rate risk, as their holdings have various maturities and degrees of interest-rate sensitivity.” Unlike normal bonds, investors can’t hold a traditional bond ETF to maturity and receive their initial investment back. To address this, some firms have launched new types of bond ETFs.
A great example is IBTE, which only holds Treasury bonds maturing between Jan. 1, 2024, and Dec. 15, 2024. The ETF is designed to mature in December 2024 like a single bond does, but also pays monthly interest like a traditional bond ETF. “Once the defined maturity ETF matures and terminates, investors will receive a final distribution in the amount of the net asset value of the ETF’s assets without any action on their part,” Andraos says. IBTE charges a low 0.07% expense ratio.
Invesco BulletShares 2024 Corporate Bond ETF (BSCO)
“There are different ‘flavors’ of defined maturity ETFs, with dates ranging from one to 10 years out covering investment grade, high-yield and municipal bonds,” Andraos says. This breadth allows advanced investors to easily customize their fixed-income allocation, all the while benefiting from the transparency and liquidity of the ETF structure. To complement IBTE with corporate bond exposure, investors can buy BSCO, which charges a 0.1% expense ratio.
This ETF holds a portfolio of investment-grade corporate bonds rated BBB and above set to mature in 2024. When Dec. 15, 2024 rolls around, BSCO will terminate, paying out its net asset value to investors. Before then, investors holding BSCO will receive monthly distributions, which is much more frequent than the usual semi-annual interest payments made by single bonds. For those looking for variety, Invesco also offers BulletShares ETFs for later dates along with high-yield and municipal issues.
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6 Smart ETFs for Low-Risk Investors originally appeared on usnews.com
Update 10/25/23: This story was previously published at an earlier date and has been updated with new information.
