Inside SPY's Legacy of Innovation

Advisors that actively follow the exchange traded funds industry likely know that the SPDR® S&P 500® ETF Trust (NYSEARCA:SPY) recently celebrated its 30th anniversary.

Commonly known by its ticker, SPY was the first ETF to trade in the U.S, but not the world’s first ETF. That distinction belongs to the TIPs 35 Fund, which listed in Toronto in 1990. Still, SPY is the first ETF in what is now, by far, the world’s largest ETF market and widely credited with touching off a now decades-long passive investing boom.

SPY has nearly $380 billion in assets under management, giving it a sizable lead over the second-largest ETF – the iShares Core S&P 500 ETF (NYSEARCA:IVV). All these facts are impressive, but something that’s really interesting and often goes overlooked is the point that SPY isn’t actually an ETF. It’s a unit investment trust (UIT).

A UIT is “a fixed portfolio that forms units that can be created and redeemed with the issuer. Because of this structure, the SPY fully replicates the S&P 500 Index, holding all members of the underlying index at their target weights,” according to Investopedia.

On that front, the relevance to advisors and clients is that UITs don’t provide for dividend reinvestment.

SPY Revolutionized Investing

At its core, SPY is an index fund, meaning that when it debuted in 1993 it wasn’t the first of its ilk. Index funds had been around for some time prior to SPY’s debut. What SPY did, however, was revolutionize how investors, well, invest.

“SPY wasn’t a new strategy, but a new way to invest. ETFs provided traders a way to manage market risk within a single instrument that traded intraday on stock exchanges. It plugged the hole between stocks and equity index futures, according to Steven Bloom, one of SPY’s architects. And its start as a trading tool has embedded it in the fabric of financial markets to this day,” writes Morningstar Bryan Armour.

Speaking of evolution and revolution, SPY certainly touched off a new, fast-growing market. Today, there are more than 5,000 exchange traded products with a combined $6 trillion in assets under management. Impressive as those data points are, they are superficial in nature. Integral to advisors’ and clients’ preferences in the active/passive debate is performance. SPY delivered the goods in that category.

“SPY’s success was critical to investors’ growing acceptance of ETFs. Since its inception, SPY outperformed 71% of U.S. equity funds available in 1993 that had survived, while only 24% of those funds remained open today,” adds Armour. “SPY jumps up to the top sixth percentile of funds since its inception after accounting for those that died. Its performance went a long way in grabbing investors’ attention and building their trust in ETFs.”

SPY Leading Passive to Victory

As is often the case with any disruptive concept or technology, it took a while for passive ETFs to catch on with market participants, including advisors that had long been fans of actively managed mutual funds. However, long-running data confirm beating the S&P 500 and other widely followed benchmarks is difficult and active managers rarely reach that goal with any consistency.

Owing to the fact that there’s only so much capital to go around, the growth of passive ETFs, led by SPY, is coming at the expense of actively managed products, confirming SPY is the leader of revolution that’s likely to be durable.

“The birth of SPY also precipitated the boom in passive investing. The popularity of index-tracking ETFs hit a fever pitch in 2022, when the spread between passive and active fund net flows hit $1.5 trillion,” concludes Morningstar’s Armour. “Despite a slow start, cumulative net flows into ETFs since SPY’s launch surpassed mutual funds starting in 2021. That gap widened significantly in favor of ETFs last year.”

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