Under The Hood: SPY vs. IVV vs. VOO
S&P 500 SPDR (SPY, A)
SPY is the oldest U.S.-listed ETF, having begun trading in 1993 as an innovation in the financial world. Since then SPY has become one of the largest and most-widely traded securities in the world; assets currently stand at about $105 billion and average daily trading volume exceeds 200 million shares. SPY is structured as a Unit Investment Trust (UIT), with State Street serving as the trustee. The UIT structure, very common among the earliest ETF products to hit the market, is somewhat restrictive–a feature that has both pros and cons [see also 5 Tips ETF Traders Must Know].
UITs must fully replicate their underlying index, and are restricted from lending out securities that make up their portfolio. For investors employing somewhat complex strategies that include options, these restrictions ensure that SPY will replicate the benchmark with near-perfect precision–reliability that investors utilizing derivatives demand. While all of the S&P 500 ETFs offer impressive liquidity, SPY also offers an incredibly-liquid options market [compare the open interests of SPY vs. IVV]. This further increases the appeal of SPY as a tool for investors looking to execute intra-day trades or those who maintain relatively short holding periods.
The trading volumes support this idea: nearly one third of SPY’s shares outstanding change hands every day; by comparison, IVV’s daily turnover is equivalent to only about 2% of shares outstanding. That implies that SPY, while certainly appropriate for buy-and-holders, is more widely used as a trading vehicle for more active traders [see also 17 ETFs For Day Traders].
Another unique feature of UITs relates to dividends. According to SPY’s prospectus, the ETF pays dividends four times annually, on the last business day of April, July, October, and January. Because SPY is a UIT, the fund cannot reinvest dividends paid by underlying holdings, but rather must hold them in cash until they are scheduled to be distributed to SPY shareholders. So if ExxonMobil, for example, pays a dividend on February 1, SPY would be required to keep that amount in cash until the end of April.
IVV, like most other ETFs, utilizes an open-end structure that provides more flexibility to the portfolio manager. Though it generally replicates the underlying index very closely, IVV is permitted to use derivatives, portfolio sampling strategies, and lend out portfolio securities to generate additional income. Perhaps most importantly, the open-end structure allows for the immediate reinvestment of dividends, potentially resulting in enhanced returns during bull markets. Whereas SPY is required to keep dividends paid out in cash, IVV has the ability to invest distributions back into the components of the S&P 500 until it is scheduled to distribute them to IVV shareholders [see also Monthly Dividend ETFdb Portfolio ].
The impact of this feature usually isn’t enormous, but it can contribute to slight return differentials between the two funds. Between the bear market lows in March 2009 (3/9/2009) and the end of that year, for example, SPY gained about 67.4%. IVV was up a slightly more impressive 67.7% during that same period. There are, of course, two sides to this coin. Reinvestment of dividends can adversely impact fund performance when markets are sinking. And indeed, during the equity market plunge of late 2008 and early 2009, SPY performed slightly better than IVV.
The most recent addition to the S&P 500 ETF space came relatively recently, as Vanguard rolled out a suite of ETFs linked to popular S&P 500 indexes. Vanguard was a pioneer in S&P 500 indexing, launching an indexed mutual fund seeking to replicate this benchmark in 1976. VOO maintains another unique structure that differentiates it from both IVV and SPY. Vanguard maintains a patent that allows it to offer ETFs as share class within larger index funds that also offer retail and institutional share classes.
There are some potential advantages to the share class structure of the Vanguard S&P 500 ETF. Although VOO is only a fraction the size of IVV and SPY, the total pool of assets across all share classes of the Vanguard product is about $94 billion. That allows VOO to offer the lowest expense ratio of the group, charging just five basis points.
While all ETFs have the ability to offer investors enhanced tax efficiency through the in-kind redemption process, VOO’s structure may offer additional tax benefits. In response to redemption requests from other classes of shareholders, Vanguard has the option to sell off high cost-basis securities, generating a capital loss in the process that can be used to offset any taxable gains. Of course redemptions of non-ETF share classes could also result in a taxable gain, but given the massive size of the S&P 500 fund such an event is unlikely unless a wave of redemptions were to occur [see Total Cost Of ETF Investing].