SPY, IVV and VOO: Be careful – not all S&P 500 ETFs are the same
By Tim Worstall
11:26, 9 January 2023
We might think that one S&P 500 ETF will be much like another. Sure, the SPDR S&P 500 ETF (SPY) is in many senses much like the iShares Core (IVV) and the Vanguard (VOO). That's not hugely a surprise, they're all supposed to be passive index trackers on the S&P 500, they're all large enough to actually hold the stocks themselves, why wouldn't they be pretty much the same?
But they're not all the same, and this is something that we need to grasp about all sorts of securities. Even tiny differences can mean that we can and should use a specific security for one case – say, speculation or trading – and another seemingly similar one for investment purposes – buy and hold strategies say.
Equally, there are some instruments which should only ever be used as a part of one of those basic approaches and never for the other because they're simply not designed for it. So much so that there are some entirely sensible products that are in fact built to lose us money if we hold them. They're built for entirely other purposes.
SPDR S&P 500 ETF (SPY) share price chart
Just to be able to create examples we're going to call speculation, or trading, what we do expecting a price movement in the next few hours to days. That would cover much FX business, some stock market and no near corporate debt trading. Conversely we’ll call investing the sort of thing we do to build our pensions. Buying something boring and sensible and sticking it away for decades with dividend reinvestment.
Do note those aren't real and firm definitions of those strategies – they're just what we're going to use for the next few paragraphs.
What is your sentiment on SPY?
Yellow Cake: hedging on uranium
So, take the example of something like Yellow Cake (LON: YCA). Effectively the company is a great big pile of yellow cake uranium, the traded form. The only reason it exists at all is to provide people with the ability to trade the uranium price. For fairly obvious reasons – like some forms of uranium can be used to make really big bangs – there're very few people with licences that allow physical trading of uranium. That then means there can't be futures – how could you deliver? - and so there's no liquid market. This makes the people who play with uranium mining stocks sad as it prevents any hedging strategies. So, create a company whose shares can be traded that should mimic the uranium price. Pretty much an ETF in fact but not of that legal form – it's closed ended, not open.
There's no point in buying YCA and tucking it away. It's not trying to build a business and grow, it's just a pile of uranium. The entire point of the existence is so that people can trade on the uranium price, hedge.
We could also look at the whole world of covered warrants, or options, futures. They're there to be traded, not invested in. A significant part of the value at any one time is the time value of them – how long before they expire? The volatility of the underlying times the time to expiry will be a more or less substantial part of their value at any one time. Locking them away into the pension fund would be ludicrous as we'd just be insisting upon losing that time value.
Illiquidity: Corporate bonds
We can also look at an entirely different class of securities, corporate bonds. Outside a very few really large issuances these are really pretty illiquid. The average corporate bond trades twice in its lifetime, at issue and redemption. That means they're pretty illiquid and that, in turn means there are wide spreads (not to say often high minimum dealing sizes: $200k nominal isn't unusual).
Wide spreads means we're leaving too much on the table each turn to want to be dealing them. There are exceptions, if there's a Chapter 11, Chapter 7, going on and we want to speculate upon recovery but those are special situations.
This horses for courses idea extends into ETFs as well, Some are deliberately designed to be traded not held, others, well, it varies on the tiny little details. For example, there is a whole series of 3x ETFs. Dirextion is only one provider and it has a whole range of products:
20 Year Treasury Bear 3x (TMV); and yes, of course, there's a Bull 3x (TMF); Semiconductor Bull 3x (SOXL) and so on.
In fact there's a whole universe of these geared ETFs. But it's that very fact of the gearing which makes them absurd vehicles for investing. For what gives them the 3x is the use of options and futures and so on inside the funds. Which leaves them subject to that decline in the time value of those instruments pointed out above.
So, the geared ETFs are guaranteed to lose money over time. They're instruments deliberately designed for speculative and hedging purposes and in the short term only. Some versions of some of them will lose 1% a day in a flat market because of this design feature.
It's like the old joke about tinned herrings* – no, these are for trading, not investing.
Some things should be used to trade in, others are for investing. Using the right instrument for the right purpose is obviously going to aid any particular strategy we're trying to employ.
Back to SPY, VOO and IVV
Which brings us back to the S&P 500 ETFs. The three I mentioned, SPY, VOO and IVV are all large enough to be holding the actual stocks in proportion so we're not going to lose time value from the structure. They're just fine to be stashed away for the ages or to be used to trade, speculate or hedge. Except they're not all equal for those two different strategies.
These will sound like very small differences but compounded over decades they do make a difference. SPY charges an annual fee of 9.45 basis points while IVV and VOO charge only 3. So, the two lower fee versions are better for that long term purpose. After all, given that all three are tracking the index better to have that index minus 3 bps rather than 9.45 year after year for many of those years. Might only mean the difference between Nescafe and Gold Blend in retirement but why let other people have the money instead of us?
On the other hand, SPY has much more trade in it – the technical word for that being liquidity. Liquidity means lower bid/ask spreads. Meaning that each time we move in and out as a trade then we're giving less of our money to the system. So, for trading – speculation, hedging – SPY is the better vehicle. Again, the difference is small, but small differences add up over time and numbers of trades.
As is obvious, there's a sweet spot in that timing where the lower bps annual fee meets the wider spread and exactly where that is is left as an exercise for the reader. This is an explanation of the background, not an explication of the optimum.
Some instruments are designed for short term positions, trading and speculation, others for the long. Some others are just better for each strategy just because, that's the way it works out. Using the right instrument for the strategy we're employing is just plain good sense. Horses for courses, tools for the task and all that. It's only the bloke who only has a hammer that thinks everything is a nail.
*I'll not insist it's a good joke. “'Arold, those tinned herrings you sold me. The Missus and I tried some, they're terrible”. “Bert, those herrings, they're for selling, not eating.”
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