Pop quiz, what is the most traded security by volume? If you were thinking Bank of America (BAC) or Facebook (FB) , good guess. Those are the highest-volume stocks out there, with each averaging over 80 million shares a day over the last three months (88.9 million for Bank of America and 82.32 million for Facebook). Microsoft (MSFT) is a distant third for stocks, trading just under 50 million shares a day. None of these, though, are the most-traded.
So the answer’s not a stock, huh? Must be an ETF. Well, among ETFs, the iShares MSCI Emerging Markets Index Fund (EEM) moves 63.71 million shares a day, and everyone’s favorite roller-coaster, the iPath S&P 500 VIX Short-Term Futures ETN (VXX) , moves 47.52 million a day. But neither of those trades more than Bank of America, so…
For many, if not most, of you, this wasn’t a difficult quiz. It’s the SPDR S&P 500 ($SPY). And it’s not even close. Moving an average of 114.3 million shares a day, SPY leaves even Bank of America in its dust. And it’s no mystery why. By giving traders and investors a like a chance to take make low-risk plays that will match the S&P 500 in returns, the SPY has become the investment vehicle of choice. Every time it’s pointed out that more than 65 percent of large-cap mutual fund fail to beat the returns of the S&P 500, a basic question is posed: why not just buy the S&P 500? And SPY is the answer to that question.
But what IS SPY really? What does it hold? How does it work? Given just how many people and institutions are using this fund, shouldn’t we dig in just a little deeper to its history and make-up? Sure we should! So here goes…
The S&P 500
Before we dig into the fund, it’s probably good to understand the index it tracks. After all, the whole point of SPY is that it has the same returns as the S&P 500. So, simply put, the S&P 500 is a list of 500 companies selected by a committee made up of industry leaders. It was introduced in 1923 by Standard & Poor’s, hence the name.
In order to be on the S&P 500, a company must A) have a market capitalization of $4 billion or greater, B) annual dollar value traded to float-adjusted market capitalization is greater than 1.0 (this is a fancy way of saying the value of the company’s stock that trades hands over the course of the year has to be more than the company’s market capitalization), and C) have a minimum monthly trading volume of 250,000 shares in each of the six months leading up to its evaluation by the committee. Basically, it has to be a big enough company and it has to be one that is actively traded by the markets.
The S&P 500 is also notable because it’s weighted by market capitalization. So, if a company’s stock is worth twice as much as another company’s stock, the first company’s price movements have twice as much effect on the index.
A History of the SPDR S&P 500
Exchange-traded funds are a relatively young method for investing, and the SPDR S&P 500, despite rapidly rising to the status of most-popular investment vehicle in the world, is only about 20-years old. It was introduced under the name Standard & Poor’s Depositary Receipts by State Street Global Advisors (STT) in 1993. It was the first exchange-traded fund available in the United States.
As exchange-traded funds go, the SPDR is pretty simply in its administration. Basically, as long as the holdings of the fund are close enough to the weighting of the index, the fund should continue to perform pretty closely to the index. And the top holdings of the SPY are only marginally different from the index. Apple (AAPL) represents 3.03 percent of the S&P 500, so the SPY holds just over 9 million shares that are good for 3.07 percent of the fund’s weight. Exxon Mobil (XOM) is 2.48 percent of both the index and the fund, Google (GOOG) is 1.81 percent of the index and 1.86 percent of the fund, and so on and so forth. In the end, the SPY holds 500 different stocks that are each between 3.07 percent and 0.01 percent of the fund’s holding (It’s J.C.Penney’s (JCP) 3 million shares bringing up the rear. Also, did you know that J.C. Penney is still on the S&P 500?).
Ultimately, the SPDR S&P 500 has done a pretty solid job of matching the performance of the S&P 500. It’s hard to imagine it would have reached its current level of popularity had it not. That said, try as they might, the good people at State Street haven’t QUITE been able to hit it right on the nose. Over the last year, the S&P 500 is up 22.25 percent while the SPY has gained 22.29 percent. Over five years, the index has gained 99.83 percent while the fund is up 101.33 percent. Over ten years it’s at 70.28 percent for the index and 69.18 percent for the fund. And since the beginning of the SPY, the index is up 299.3 percent to the fund’s 298.84 percent. While this isn’t matching perfectly, it’s certainly close enough for anyone other than the most discerning investor, and the fact that it varies between under- and over-performing the index demonstrates that it’s not consistently off in the same way.
The SPY also offers a dividend yield of 1.94 percent on what’s been $0.84 a share for the last two quarters. So, on the whole, the fund’s returns are strong, especially when one considers that the performance of the S&P includes dividends as part of its returns. And as far as expense ratios go, the SPY is clearly a better options than the majority of its competing mutual funds because its 0.11 expense ratio makes it a significant bargain.