Assessing the Performance and Value Proposition of VanEck Morningstar SMID Moat ETF (SMOT) in a Rising Rate Environment

In the ever-evolving landscape of equity investing, smart beta strategies have emerged as a compelling alternative to traditional market-cap-weighted indices. The VanEck Morningstar SMID Moat ETF (SMOT) is one such product, designed to capture the growth potential of small- and mid-cap companies with durable competitive advantages—so-called “moats”—and attractive valuations. However, as the Federal Reserve's aggressive rate hikes in 2024–2025 reshape market dynamics, investors must critically evaluate whether SMOT's smart beta approach can withstand the headwinds of a rising interest rate environment.

The Smart Beta Framework: A Double-Edged Sword

SMOT's strategy diverges from conventional indexing by leveraging Morningstar's proprietary equity research to identify firms with strong fundamentals. The fund's holdings—approximately 107 companies as of August 2025—are selected based on metrics like economic moats, valuation discounts, and long-term growth potential. This approach aims to mitigate the influence of market capitalization distortions, which often overweigh popular but overvalued stocks.

Yet, the same characteristics that make SMOT appealing also expose it to unique risks. Small- and mid-cap equities, by nature, are more sensitive to macroeconomic shifts and liquidity constraints. In a rising rate environment, borrowing costs rise, discount rates increase, and investors often retreat to safer assets, all of which disproportionately impact smaller companies. SMOT's beta of 1.28 and standard deviation of 19.35% over three years underscore its heightened volatility compared to the S&P 500, a trend that has amplified during periods of rate hikes.

Risk-Adjusted Returns: A Mixed Bag

To assess SMOT's efficacy, we turn to risk-adjusted performance metrics, which provide a clearer picture of its value proposition. As of August 2025, SMOT's Sharpe ratio stands at 0.68, lagging behind the S&P 500's 0.80. This suggests that while the ETF has generated positive returns, it has done so with less efficiency in balancing risk and reward. The Sortino ratio (1.10 vs. 1.30 for the market) and Omega ratio (1.15 vs. 1.20) further reinforce this narrative, indicating that SMOT's downside protection and overall risk-return profile trail the broader market.

The Calmar ratio, which measures annualized returns relative to maximum drawdowns, paints an even starker picture. SMOT's 0.64 Calmar ratio—compared to the S&P 500's 0.85—highlights its vulnerability to sharp corrections. The ETF's worst drawdown of 23.36% in April 2025, coupled with a current drawdown of 1.48%, underscores its susceptibility to market stress.

Navigating the Rising Rate Environment

The challenges for SMOT are compounded by the structural shifts in 2024–2025. Small-cap value stocks, which dominate the fund's exposure, have historically underperformed during rate hikes. For instance, SMOT's year-to-date return of 4.19% as of late 2025 contrasts sharply with its 12-month return of 14.97%, reflecting the uneven terrain of a tightening monetary policy. Monthly volatility has been pronounced: a 5.45% gain in January 2025 was followed by a -7.50% drop in March, illustrating the fund's sensitivity to macroeconomic news cycles.

Moreover, SMOT's expense ratio of 0.49%—while reasonable for a smart beta ETF—pales against the 0.03% of broad-market alternatives like the iShares Core S&P Total U.S. Stock Market ETF (ITOT). This cost differential may erode returns further in a low-growth environment where every basis point matters.

Strategic Considerations for Investors

For investors considering SMOT, the key lies in aligning the fund's risk profile with their portfolio's overall objectives. While the ETF's focus on moat-driven companies offers long-term growth potential, its current risk-adjusted metrics suggest it may not be the optimal choice for risk-averse investors or those seeking stable returns in a high-rate climate. However, for those with a higher risk tolerance and a strategic allocation to small/mid-cap equities, SMOT could serve as a complementary tool—particularly if held alongside defensive assets to balance volatility.

Conclusion

The VanEck Morningstar SMID Moat ETF embodies the promise and perils of smart beta investing. Its focus on fundamentally strong, undervalued companies is a compelling narrative, but the rising rate environment of 2024–2025 has exposed the fund's vulnerabilities. While SMOT's strategy may thrive in a more accommodative monetary policy regime, its current risk-adjusted performance suggests caution. Investors should weigh the fund's potential for long-term outperformance against its short-term volatility and consider diversifying across asset classes to mitigate the risks of a prolonged rate hike cycle.