Plain Vanilla: Large Cap ETFs Compared
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Plain vanilla large cap US ETFs are the most popular of any asset class, so comparing them is definitely worthwhile. We examine both subtle and obvious features to turn up differences.
The SPDR ETF (AMEX:SPY) holds about 1/10th of all ETF assets at over $70 Billion. Direct competitor iShares S&P 500 ETF (NYSEArca:IVV), which targets the same S&P 500 index, charges .01% less in annual fees per year. Do this mean that unwitting investors are leaving $7 Million on the table every year, or are there justifications for buying SPY beyond brand recognition?
Apparently, there is no difference. The two firms' own data that Q2 2008 returns for the funds were an identical -11.91%. More tellingly, a five-year period through Q2 likewise ended in an identical 7.47% annualized return. Comparing these two funds is made tricky by different dividend distribution calendars. SPY pays quarterly while IVV pays bi-annually. Saving up cash during an extra quarter makes IVV look better just prior to dividend dates, but if you assume all dividends are reinvested then the systems can be made equivalent. Unfortunately, external data sources are not always adept at making this calculation.
Even though SPY's annual costs are .10% vs. IVV's .09%, we see no evidence that SPY investors are taking the hit in the end. SPY may be one of those funds with clever managers who navigate index composition changes well. In addition, its specialists (or authorized participants) who create and redeem the fund may be driving slightly smaller spreads due to the fund's incredible economy of scale.
Should investors bother with a difference of .01% in performance per year? Over a ten-year period it will create only a bit more than one-tenth of a percent difference in a portfolio, all else being equal. Every penny counts, but it's not a material sum. Some investors may wish to reward providers who run operations lean, so it's as much a matter of philosophy as actual economics.
There are, of course, other fine large cap alternatives. Vanguard's Large Cap ETF (AMEX:VV) follows the top 750 US stocks using the MSCI US Prime Market 750 Index. If you want some smaller mid-cap stocks thrown in, this is a fine choice. Its fees can't be beat, and Vanguard has a reputation for tracking indexes well. Also, there is likely to be far less fallout from additions and deletions to this index as with the wildly popular S&P 500. When a company is added or deleted from the S&P 500, its stock can swing by 5% or more, to the detriment of index funds which must sell the losers or buy the winners all at the same time. Making things worse, arbitrageurs may jump ahead of them and drive prices further by guessing correctly which firms will get the nod or the boot.
Competing with VV is the SPDR Dow Jones Wilshire Large Cap ETF (AMEX:ELR), whose DJ Wilshire Large Cap Index also follows about 750 ETFs. This time the fee difference is not a hair's breath. VV charges .07% vs. ELR's .20%. Curious to see if this makes a difference, we looked up recent returns and found this time the more expensive ELR leading by -1.82% to VV's -1.89% in Q2 and even more in Q1. Inexpensive funds, alas, are no guarantee of superiority even among similar funds. We should note that even with similar targetting, these two indexes of 750 stocks have ever so slightly different methodologies and holdings. Random variation from these differences can be expected to cause one to do better than the other on any given quarter, but we doubt there is predictability.
We said earlier that .01% in fee differences is not significant, but someone even bother with a difference of .13% in performance per year? Here it may be argued that the difference is material. Over a ten-year period it will create more than 1.3% difference in a portfolio, all else being equal. For a retirement fund topping off at one million dollars, this comes to more than $13,000. The providers are both top flight, so we have to recommend the lower cost Vanguard offering for lack of other differentiating factor.
We come, nonetheless, to the happy conclusion that in large cap competition is sufficiently stiff that it remains difficult to call winners. This is comforting news, given the amount of money held by these funds.
The main consideration is the appropriate breadth of market. In this regard there are more choices. The iShares S&P 100 ETF (AMEX:OEF) targets only mega-cap companies, while the iShares Russell 1000 ETF (NYSEArca:IWB) cuts a wide swath with many mid-cap firms. 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, so they have an inherent currency hedge against a falling dollar. In addition, they diversify their exposure to many economies. On the other hand, they are less likely to benefit from a sharp upswing in the US economy as smaller, more domestic-oriented firms. It's a matter of judging the market cycle. Clearly, the US economy is among the weakest of the G8 economies, if not the weakest, and the dollar is still under pressure. However, some other economies are sure to follow the US slowdown, and the dollar has retreated so far that it seems ahistorical to predict its complete collapse.