You’re In The Wrong Large Cap ETF

August 27, 2014

Making The Right Choice

So what’s the “right” fund here? If you’re a long-term, buy-and-hold investor who likes the familiarity of the S&P 500, it’s hard to argue with the simplicity of buying cheap. There are two reasons the Vanguard S&P 500 ETF (VOO | A-96) has outperformed SPY this last year, and why you’d expect it to going forward. The first is simply cost.

While the 4 bps differential in performance may seem like splitting hairs, why not at least have the light breeze at your back? The second is structure. SPY is a unit investment trust under the hood. That means it can’t take the cash that comes in from dividends and invest it in, say, S&P 500 futures for the few weeks until it sends a dividend check out to shareholders. That creates a tiny amount of cash drag that serves to lower its beta.

In other words, in up markets, you’d expect SPY to trail a more traditional, ’40 Act-based fund like VOO, which invests its received dividends in short-term securities of futures before distributing to investors.

And that’s exactly what has happened: Since VOO started tracking the S&P 500 in September 2010, it has returned an annualized 18.69 percent compared with SPY’s 18.58 percent. Put another way, the SPY investor is up 96.55 percent in those four years, and the VOO investor is up 97.27 percent.

It’s not a difference that makes or breaks your retirement, but investing is often about making the subtle changes.

And for what it’s worth, our Analyst Pick from this list doesn’t even track the S&P 500. The S&P 500 has a few strikes against it, from a purely academic perspective: It’s committee selected, and it fishes well down into the midcap space.

Our pick in the space, the Vanguard MegaCap ETF (MGC | A-100), avoids both of these problems, being fully and solely large-cap, entirely rules based and pretty darn cheap, to boot.



At the time of this writing, the author held no positions in the securities listed. You can reach Dave Nadig at [email protected], or follow him on Twitter @DaveNadig.


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