Large Cap ETFs

Thursday, July 8, 2010

Large cap ETFs are the most popular of all categories, but often they are taken for granted. While differences between funds are mostly subtle, the sheer amount of money placed in these ETFs makes it prudent to understand them.

Plain vanilla, low-cost S&P 500 ETFs are where many investors park the core of their stock portfolio before they shop for satellite ETFs. SPDR S&P 500 (AMEX:SPY) handles an astounding $66 Billion, while iShares S&P 500 ETF (NYSEArca:IVV) runs $18 Billion. These two funds alone normally account for over 10% of all ETF assets. Both charge a paltry 0.09% in annual fees.

There are minor differences between how the funds operate. SPY pays dividends quarterly while IVV pays bi-annually. The funds navigate index composition changes differently. SPY's spectacular economies of scale drive bid-ask spreads down to minute levels, but IVV's are also impressive. We see no obvious evidence of superiority of one fund over the other.

The main decision by large cap investors is where to drawn the line on size, as there are several alternatives to the S&P 500 format. One alternative is with the largest 750 US stocks such as found in Vanguard's Large Cap ETF (AMEX:VV), with 0.12% fees. It follows the MSCI US Prime Market 750 Index, which throws smaller companies into the mix but still remains arguably large cap. Its main attraction is avoiding fallout from additions and deletions which can affect the popular S&P 500. When a company is added or deleted from the S&P 500, its stock can swing several percentage points up or down. This is always to the detriment of index funds which must sell the losers and buy the winners. Arbitrageurs commonly jump ahead of them and drive prices further even away.

Competing with VV is the SPDR Dow Jones Wilshire Large Cap ETF (AMEX:ELR), whose DJ Wilshire Large Cap Index also follows about 750 companies at 0.23% annual cost.

Despite all the theoretical differences, actual returns are highly correlated in practice:

There are other ways to constrain or stretch the large cap definition. The iShares S&P 100 ETF (AMEX:OEF) targets only mega-cap companies, while the iShares Russell 1000 ETF (NYSEArca:IWB) takes in some mid-cap firms.

Whatever the definition of large cap, similar considerations of economic cycles, international exposure and portfolio diversification also come into play.

Larger firms are far more likely to have international subsidiaries earning foreign currencies than smaller ones, so they have an inherent currency hedge against a falling dollar but participate less in its rise. Also, the largest firms tend to diversify their exposure to other economies and should suffer less from US debt woes. By the same token, they are less likely to benefit from a sharp upswing in the US economy as smaller, more domestic-oriented firms. Picking the appropriate ETF is a matter of judging the current state of economic cycles.

Low fees are always welcome, and over time even a modest difference adds up. For example, an annual difference of even 0.10% will lower returns about 1.3% by the end of a ten-year period, all else being equal. It is enough to start taking notice if a substantial portion of a portfolio is deployed to large cap, which often is the case.

Other ETF plays on large cap include various using fundamental financial ratios to filter out and select companies deemed to be more attractive:

  • PowerShares Dynamic Large Cap Growth Portfolio ETF (AMEX: PWB); 0.6% annual fees
  • PowerShares Dynamic Large Cap Portfolio ETF (AMEX:PJF); 0.6% annual fees
  • PowerShares Dynamic Large Cap Value ETF (AMEX:PWV); 0.6% annual fees
  • RevenueShares Large Cap ETF (NYSEArca:RWL); 0.54% fees
  • WisdomTree LargeCap Dividend ETF (NYSEArca :DLN); 0.28% fees
  • ELEMENTS SPECTRUM Large Cap US Sector ETN (NYSEArca:EEH); 0.75% fees
  • First Trust Large Cap Core AlphaDEX ETF (NYSEArca:FEX); 0.7% fees

There are also some large cap ETFs which allow for style investing, or weighting towards growth or value:

  • SPDR Dow Jones Wilshire Large Cap Growth ETF (AMEX:ELG); 0.2% fees
  • SPDR Dow Jones Wilshire Large Cap Value ETF (AMEX:ELV); 0.2% fees
  • iShares Morningstar Large Core ETF (NYSEArca:JKD); 0.2% fees
  • iShares Morningstar Large Growth ETF (NYSEArca:JKE); 0.25% fees
  • iShares Morningstar Large Value ETF (NYSEArca:JKF); 0.25% fees
  • Then there are ETFs which combine fundamental and style investing:
  • Claymore Great Companies Large-Cap Growth ETF (AMEX:XGC); 0.6%
  • ELEMENTS Benjamin Graham Large Cap Value Total Return ETN (NYSEArca:BVL); 0.75%
  • First Trust Large Cap Growth Opportunities AlphaDEX ETF (NYSEArca:FTC); 0.7%
  • First Trust Large Cap Value Opportunities AlphaDEX ETF (NYSEArca:FTA); 0.7%
  • Grail American Beacon Large Cap Value ETF (NYSEArca:GVT); 0.79%
  • Wisdom Tree Large Cap Growth ETF (NYSEArca: ROI); 0.38%

Finally there are the traders' vehicles, suitable only for speculative bets over short time periods:

  • Direxion Large Cap Bear 3x Shares ETF (NYSEArca:BGZ); 0.95%
  • Direxion Large Cap Bull 3x Shares ETF (NYSEArca:BGU); 0.95%

Co-founder of indexfunds.com, author of two books on investing, and founder of ETFzone.com, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.