Two ETFs with Durable Moats for the Long-Term Compounding Investor

For the disciplined investor, the goal is not to chase returns but to compound capital through time by owning businesses with durable advantages. This requires a checklist that goes beyond simple market exposure. The core principle is the margin of safety: focusing on companies with sustainable competitive advantages, or "moats," trading at reasonable valuations. This approach, championed by Buffett and Munger, seeks to buy a dollar's worth of business for fifty cents, a gap that provides a buffer against error and market swings.

Two ETFs exemplify this philosophy. The first is the Invesco S&P 500 Quality ETF (SPHQ). Its strategy is straightforward: it targets the top 100 companies from the S&P 500 based on a rigorous assessment of profitability, low leverage, and stable earnings growth. This is a classic value screen, filtering for the highest-quality large-cap businesses that have demonstrated the ability to generate consistent returns on capital-a key indicator of a wide moat. By focusing on these fundamentals, SPHQ aims to deliver risk-adjusted returns that outlast fleeting market fads.

The second ETF, the VanEck Morningstar SMID Moat ETF (SMOT), applies the moat concept to a different segment. It follows an index that selects small- and mid-cap companies with sustainable competitive advantages, using Morningstar's proprietary methodology. The fund's strategy is to identify businesses with durable economic advantages that are often overlooked by larger institutions. Its recent performance underscores the potential of this approach; SMOT has beaten its benchmark by more than 100 basis points in recent months, demonstrating how focused selection can outperform broad market indices. This is the essence of value investing: finding undervalued quality where the market's attention is elsewhere.

Analyzing SPHQ: Quality in the Core

The Invesco S&P 500 Quality ETF (SPHQ) is built on a simple, powerful premise: over the long term, the highest-quality businesses compound capital most effectively. Its portfolio design is a direct application of this principle. The fund selects the top 100 companies from the S&P 500 based on a score that prioritizes profitability, low leverage, and stable earnings growth. The result is a concentrated portfolio where roughly 77% of the holdings are rated as having a wide economic moat-a significant advantage over the broader market. This focus on durable competitive advantages is the engine for its long-term goal: strong risk-adjusted returns through full market cycles.

The fund's expense ratio of 0.15% is a critical enabler of that goal. For a core holding, minimizing cost drag is non-negotiable. This low fee ensures that the compounding process is not eroded by excessive management costs, allowing the underlying quality of the holdings to shine through over decades.

Performance data supports the strategy's resilience, particularly in adversity. While the fund may lag in strong, frothy markets where growth stocks dominate, its true value emerges during volatility. Evidence shows it has consistently outperformed in turbulent times, beating the category index by 84 basis points during the market shock in March 2020. This defensive characteristic is a hallmark of quality investing, where strong balance sheets and stable earnings provide a buffer. The fund's ranking in the top 1% of all large-blend funds over the 15 years through October 2024 underscores its ability to deliver superior risk-adjusted returns over the long haul.

For the value investor, SPHQ represents a disciplined core holding. It is not a bet on the next trend, but a commitment to the timeless principle that durable competitive advantages, when bought at reasonable prices, compound capital most effectively. Its design, low cost, and proven resilience during market stress make it a cornerstone for any long-term portfolio.

Analyzing SMOT: The Small-Cap Moat Opportunity

The VanEck Morningstar SMID Moat ETF (SMOT) targets a specific, often overlooked segment of the market: small- and mid-cap companies with durable competitive advantages. Its strategy is built on a simple, powerful idea: true economic moats can be found outside the S&P 500, and they often come with a more attractive price tag. The fund seeks to track an index that is intended to track the overall performance of small- and mid-cap companies with sustainable competitive advantages and attractive valuations according to Morningstar's equity research team. This is not a passive index fund; it is a concentrated portfolio built on active research, aiming to identify the compounding engines that institutional investors may miss.

This focused approach has recently paid off handsomely. The ETF has delivered a 17.52% YTD gain in 2025, a performance that has outpaced its small-cap benchmark. This surge is not random. It is being driven by a clear market catalyst: the expectation of a renewed domestic economic focus under the new administration. As noted, small- and mid-cap companies are much more likely to have customer bases that are either exclusively or predominantly in the United States. This makes them a direct proxy for the "American exceptionalism" narrative, where policies favoring domestic production and investment are anticipated to benefit these businesses. In this setup, SMOT provides a targeted, high-conviction way to gain that exposure.

For the long-term investor, SMOT's role is best understood as a satellite holding. Its non-diversified nature and focus on a specific segment mean it carries more volatility than a broad market core. Yet, this is precisely its value. It offers a diversification benefit by accessing a different set of compounding engines. The fund's index is designed to identify small- and medium-capitalization companies that Morningstar determines have sustainable competitive advantages based on a proprietary methodology, with a particular emphasis on those trading at attractive multiples. This focus on wide-moat stocks in a less-expensive asset class provides a potential margin of safety and a path to long-term capital appreciation that is distinct from the large-cap market.

The bottom line is that SMOT is a tactical, high-conviction play on a specific market theme and a specific segment of the economy. Its recent performance shows the power of focused selection, but its long-term value will be measured by its ability to compound through cycles. For the patient investor, it represents a disciplined way to tilt the portfolio toward overlooked quality, where the market's attention-and its price-may not yet be fully aligned with the business's durable advantages.

Catalysts, Risks, and the Long-Term View

For the long-term investor, the focus must be on the durable drivers of value. The recent performance of these moat-focused ETFs is a reminder that catalysts are often macroeconomic or policy-driven, while the ultimate test is resilience through cycles.

The primary catalyst for SMOT is a clear policy narrative. The expectation that a new administration will prioritize "American exceptionalism" is a direct tailwind for smaller, domestically-focused companies. As noted, small- and mid-cap companies are much more likely to have customer bases that are either exclusively or predominantly in the United States. This makes SMOT a targeted play on a potential shift in economic policy that favors domestic production and investment. The fund's recent outperformance, beating the small-cap benchmark by more than 100 basis points in recent months, suggests this catalyst is already in motion. Investors should monitor the actual rollout of such policies and the resulting impact on the earnings of these smaller, moat-protected businesses.

For both SPHQ and SMOT, the major risk is concentration. SPHQ's focus on the top 100 large-cap quality names means it is sensitive to leadership shifts within that elite group. SMOT's tilt toward small- and mid-caps introduces higher volatility and sector concentration risk, as highlighted by the key risks of "small-/mid-cap volatility" and "concentration in technology shares." This concentration makes the funds vulnerable to sector rotations and market leadership changes. When the market favors growth or momentum, the quality and value screens that define these ETFs can lead to underperformance, as seen with similar quality funds in 2025. The long-term investor must accept this trade-off: a potential drag in strong bull markets for the benefit of a smoother ride through downturns.

The ultimate metric for success is consistent, superior risk-adjusted returns over a full market cycle. Evidence from the past shows this is possible. SPHQ demonstrated its defensive moat during the March 2020 market shock, beating the category index by 84 basis points. This kind of outperformance during adversity is the hallmark of a durable strategy. Investors should monitor whether these ETFs can replicate that resilience in future periods of stress. The goal is not to chase the highest absolute return in every year, but to compound capital with less volatility and a higher probability of recovery when the market turns. In that sense, the catalysts are the wind at their back, but the moat is what ensures they can sail through the storm.