You’re In The Wrong Large Cap ETF

With the S&P 500 topping 2,000, it’s worth understanding how you ended up in the wrong large-cap ETF.

Reviewed by: Dave Nadig
Edited by: Dave Nadig

With the S&P 500 topping 2,000, it’s worth understanding how you ended up in the wrong large-cap ETF.

First, I’ll admit that the title here is a bit tongue in cheek. ETFs purporting to provide core large-cap U.S. equity exposure account for more than $363 billion of ETFs—a huge chunk of the entire ETF market. But as you might expect, even though there are 67 ETFs in the segment, most of the assets are in the top 10—and really, in one fund:

Fund NameSymbolExpense RatioAUM
SPDR S&P 500SPY0.09%$171,552,111,917
iShares Core S&P 500IVV0.07%$60,756,395,000
PowerShares QQQQQQ0.20%$46,271,767,500
Vanguard S&P 500VOO0.05%$21,364,747,800
SPDR Dow Jones Industrial Average TrustDIA0.17%$11,224,325,777
iShares Russell 1000IWB0.15%$9,795,871,000
Guggenheim S&P 500 Equal WeightRSP0.40%$8,554,424,280
Vanguard Large-CapVV0.09%$5,241,077,520
PowerShares S&P 500 Low VolatilitySPLV0.25%$4,615,212,000
iShares S&P 100OEF0.20%$4,516,208,000

Yep: the SPDR S&P 500 (SPY | A-98). This is a surprise to exactly nobody, and the best example of first-mover advantage I’ve read outside of a Tom Peters book. Going down this list, there are a lot of choices here.

You have three flavors of plain-vanilla S&P 500 exposure, with expense ratios ranging from just 5 basis points with the Vanguard S&P 500 ETF (VOO | A-96) to SPY at 9 bps. You’ve got some old-guard, slightly wacky ETFs like the PowerShares QQQ (QQQ | A-45) and the SPDR Dow Jones Industrial Average (DIA | A-73), and then you’ve got different takes on skinning the large-cap cat, with different weighting schemes, smaller or larger selection universes, and even the low-vol play.

By any rational standards, these are all fantastic ETFs. They’re cheap, they trade like water and they deliver on their promise to investors.

But that doesn’t make them identical, and it doesn’t mean that they’re interchangeable, and all too often, I think investors simply fish from the top of this list because it’s easy.


Looking At Performance

But let’s reorder the list based on that other shorthand—past performance:

Fund NameSymbolAUM1-Year Total Return
PowerShares QQQQQQ$46,271,767,50031.64%
PowerShares S&P 500 High BetaSPHB$326,556,00030.44%
Direxion NASDAQ-100 Equal WeightedQQQE$26,953,01427.43%
First Trust NASDAQ-100 Equal WeightedQQEW$444,983,50027.12%
ProShares Large Cap Core PlusCSM$370,348,00026.05%
RBS NASDAQ-100 Trendpilot ETNTNDQ$275,617,68625.68%
AdvisorShares Madrona Forward DomesticFWDD$29,351,00024.79%
Forensic AccountingFLAG$14,472,00023.42%
Barclays ETN+ Shiller CAPE ETNCAPE$21,171,97923.36%

In this case, I have a harder time piling on the praise. Most of these funds are highly skewed takes on what it means to be a large-cap index. Four are based on the Nasdaq 100, an unusual index that not only fishes from a narrow pool (just Nasdaq-listed stocks) but has odd weighting and rebalance mechanisms.

The list is rounded out by very specific quasi-active approaches to picking outperforming large-cap stocks, whether through looking at fundamentals or actually going long and short (in the case of the ProShares Large Cap Core Plus ETF (CSM | B-88)).

Again, there’s nothing inherently terrible here, but these are all very specific and narrow approaches, and I think it’s unlikely anyone stumbles into them by accident. If you did, well, you’re part of the “not reading the prospectus” problem. Obviously, there’s real money at work in some of these funds, and for the last year at least, it’s been the smarter money than the core large-cap money.


Focus On Core Exposure

But what about real, core exposure? After all, most investors are looking to grow their assets slowly over the long term, and a solid large-cap U.S. ETF is the smart place to start. If you go through and remove the idiosyncratic indexes, and all the quasi-active plays, and all the various factor and volatility skewed portfolios, and all of the ETFs that are less than a year old, this is the list I come up with:

Fund NameSymbolExpense RatioAUM1 Year5 YearSpread %
Guggenheim S&P 500 Equal WeightRSP0.40%$8,554,424,28022.88%18.62%0.02%
SPDR Russell 1000ONEK0.20%$51,671,91622.74%16.73%0.19%
Vanguard Mega CapMGC0.12%$797,472,00022.72%16.36%0.04%
RevenueShares Large CapRWL0.49%$254,124,09022.69%16.72%0.18%
Vanguard S&P 500VOO0.05%$21,364,747,80022.66%--0.01%
Vanguard Large-CapVV0.09%$5,241,077,52022.63%16.83%0.02%
iShares Russell Top 200IWL0.15%$131,515,00022.62%--0.12%
iShares Core S&P 500IVV0.07%$60,756,395,00022.60%16.59%0.01%
Schwab U.S. Large-CapSCHX0.04%$3,130,051,56522.60%--0.03%
SPDR S&P 500SPY0.09%$171,552,111,91722.52%16.55%0.01%
iShares Russell 1000IWB0.15%$9,795,871,00022.52%16.85%0.02%
Vanguard Russell 1000VONE0.12%$358,566,00022.52%--0.09%
WisdomTree Earnings 500EPS0.28%$114,702,75322.20%16.41%0.23%
Guggenheim Russell 1000 Equal WeightEWRI0.40%$121,320,00022.17%--0.21%
PowerShares FTSE RAFI US 1000PRF0.39%$3,799,075,00021.87%16.70%0.03%

There are a few things to note on this list. The first is I’ve included some edge cases that I’m sure my director of research will consider far too smart to be on a “vanilla” list, with the PowerShares FTSE RAFI US 1000 (PRF | A-89) being the most controversial example. PRF is in the class of smart-beta ETFs that selects its securities not just by weight but by fundamental measures like book value, cash flow, sales and dividends.

You’ll note, however, that on a performance basis, and indeed on a portfolio basis, it ends up looking very, very similar to most of the other funds on this list. The same is true for most of the equal-weighted, revenue-weighted and earnings-weighted ETFs here.

The one notable exception is the Guggenheim S&P 500 Equal Weight ETF (RSP | A-79). During the fantastic past five years, it’s outperformed most of these other core equity ETFs by about 2 percent a year, more than earning back its 40 bps expense ratio.

If that sounds too good to be true, consider the not insignificant risks you’ve taken by being in RSP. Instead of an average market cap of around $140 billion (the average in our benchmark for the segment, the MSCI USA Large Cap index), your average market cap has been just $36 billion.

RSP is in fact nearly 40 percent midcaps. It’s also been heavily skewed in the business cycle, with 17 percent in consumer cyclical stocks, versus 12 percent in the broader large-cap market.

All this has given the fund a higher beta to the market than, say SPY. When the market’s going up, that higher beta is great, and it’s paid off. In any downturn, however, you’d expect it to fall faster, and further.


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.


Prior to becoming chief investment officer and director of research at ETF Trends, Dave Nadig was managing director of Previously, he was director of ETFs at FactSet Research Systems. Before that, as managing director at BGI, Nadig helped design some of the first ETFs. As co-founder of Cerulli Associates, he conducted some of the earliest research on fee-only financial advisors and the rise of indexing.