Large Cap: Different Flavors of Vanilla

By Will McClatchy, ETFzone.com

Friday, July 31, 2009

Large cap ETFs are the most popular of all, but often they are taken for granted. There are both obvious and subtle differences among ETFs in this essential asset class.

Plain vanilla, low-cost S&P 500 ETFs are the giants of the ETF industry. This is where most investors come to park their money for long periods at phenomenally low cost. SPDR S&P 500 (AMEX:SPY) handles an astounding $63 Billion in assets at a cost of .10% in annual fees, while iShares S&P 500 ETF (NYSEArca:IVV) runs $18 Billion for .09% in annual fees.

One might expect these two funds to track each other closely, with IVV at best squeaking out a tiny bit more return due to its lower fees. And indeed in the summer of 2008 their returns including fees were identical for both 1 and 5-year periods. In 2009 through June the picture was much less tidy and SPY slipped ahead:

	Year-to-date	1 Year	5 Year
SPY	3.17%	-26.02%	-2.28%
IVV	3.18%	-26.13%	-2.28%

There are slight differences between how the funds operate. SPY pays dividends quarterly while IVV pays bi-annually. Their managers navigate index composition changes differently. And specialists (or authorized participants) who create and redeem the ETF shares can use economies of scale (SPY would benefit here) to drive smaller bid-ask spreads. This is important only to the degree the investor trades. We see no obvious evidence of superiority of one fund over the other, and the .01% fee difference is hardly worth noticing to most investors.

There are, of course, other fine large cap alternatives, and they present interesting comparisons of their own. Vanguard's Large Cap ETF (AMEX:VV), 0.07% fees, ($2 Billon in assets) follows the top 750 US stocks using the MSCI US Prime Market 750 Index. If one wants smaller companies thrown into the mix, this is a fine choice, and it's still arguably large cap. Its fees can't be beat, and there is likely to be far less fallout from additions and deletions to this index than 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 and buy the winners all together. 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 companies. In this case the fee difference is much greater. ELR charges 0.20% vs. VV's 0.07%. Last year we reported the more expensive ELR leading after fees by -1.82% to VV's -1.89% in Q2 and even more in Q1. This year year-to-date returns are again favorable for ELR at 3.94% against 3.64% for VV. But over three years VV has outpaced ELR by a pinch, -7.82% to -7.92%. We doubt that there is no pattern to be exploited.

Low fees are no guarantee of superiority over a similar fund, but when fee differences become substantial the likelihood of long-term outperformance certainly improves. So while a 0.01% difference in fees is immaterial, a difference of 0.13% is another matter. Over a ten-year period it will create more than 1.3% difference in a portfolio, all else being equal, which is enough to start taking notice.

There are lots of ways to 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. 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. They diversify their exposure to many economies and will suffer less from US debt woes. 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.

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.