Why S&P 500 ETF Returns Are Dispersed

October 03, 2013

Who knew that index funds targeting the S&P 500 Index could be so different from one another?

The S&P 500 has rallied about 20 percent year-to-date, forging record highs along the way, and many ETF investors have added exposure to the broad U..S large-cap market in the meantime, as massive flows into U.S. equities ETFs so far this year suggest. But when it comes to owning the S&P 500 through an ETF, investors have plenty of funds to choose from, and their results can be vastly different.

To be fair, there are only three ETFs among the 1,500-plus ETFs in the market today that set out to track the S&P 500 directly, and there’s no question that the SPDR S&P 500 ETF (SPY | A-99) is the first ETF that comes to mind when investors think about an allocation to the broad benchmark of U.S. large-cap equities.

It’s the world’s largest and oldest ETF, with more than $145 billion in assets, and it’s one of the most widely traded securities in financial markets globally. Also, it comes with a competitive price tag relative to other ETFs—0.09 percent a year, or $9 per $10,000 invested.

But SPY is structured as a trust rather than as an investment company under the Investment Company Act of 1940—its iShares and Vanguard competitors are ’40 Act funds—meaning its issuer can’t lend out shares to help cover costs, or reinvest dividends into the fund. These traits cause it to deviate further from its benchmark’s performance than competing ETFs, which ultimately translates into higher costs for investors relative to owning, say, the iShares Core S&P 500 ETF (IVV | A-99), or the Vanguard S&P 500 ETF (VOO | A-97).

That price difference is important because when it comes to tracking the S&P 500, these three ETFs do a superb job at delivering similar returns to that of the benchmark, making price a key differentiator between the funds—SPY, IVV and VOO have each seen total returns of about 20.6 percent year-to-date. In an era where investors are starved for yield in a low-interest-rate environment, out-of-pocket costs have become ever-so important in the decision-making process of choosing an investment vehicle.

In the past 12 months, SPY has seen a median tracking difference of about -0.16 percent, meaning it has lagged the S&P 500 index by 7 basis points beyond its expense ratio. That tracking error equates to costs and, in this case, it means investors are actually paying about 0.16 percent a year, or $16 per $10,000, to hold SPY rather than the reported expense ratio of 0.09 percent. That number doesn’t account for trading spreads, which are another cost investors need to consider, although here, spreads are typically extremely narrow due to the fund’s massive liquidity.

To put that number into context, the competing $45 billion IVV, for instance, not only comes with a competitive 0.07 percent expense ratio relative to SPY, but its median tracking difference is lower, at -0.08 percent, in a similar 12 month period—only a 1 basis point difference that’s being added to investors’ overall costs for holding the fund. That difference is most likely linked to the fund’s 40-Act structure, which allows it to lend securities and reinvest dividends.

That’s also the case for the cheapest of the three, the $11.8 billion VOO, which comes with an expense ratio of 0.05 percent—the lowest in the segment for a plain S&P 500 fund—and a median tracking difference of just -0.03 percent.

SPY_IVV_RSP_SPLV_YTD_Performance

Chart courtesy of StockCharts.com


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