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SPY@20: S&P 500 & Indexing, The Perfect Mix

Cinthia Murphy


Editor’s Note:This story is part of a “SPY@20” series of pieces IndexUniverse is rolling out this week and next to commemorate the 20 th anniversary of the first U.S.-listed ETF. The package will include a number of interviews with industry sources as well as blogs from IndexUniverse senior executives. The stories that have run include the following:

  • SPY@20:First ETF Changed Investing


Celebrating the 20 th anniversary of the first U.S. exchange-traded fund, the SPDR S'P 500 ETF (SPY) is an opportunity for James Ross, global head of ETFs at State Street Global Advisors, to take measure of all that’s transpired regarding ETFs in two decades.

Ross told IndexUniverse.com Correspondent Cinthia Murphy that it’s still a surprise that SPY, the biggest ETF in the world, has become a $125 billion fund that makes up about 9 percent of the $1.4 billion that is now invested in U.S.-listed ETFs.

But at this point it’s hard to imagine that SPY won’t be as relevant to the next phase of ETF development as it was to its beginnings, says Ross. And through it, Ross has never ceased to view investor education at the core of SPY’s success and of the future viability of the entire ETF industry.


IU.com:SPY is turning 20. Where were you when the first-ever ETF came to be, and what role did you play in its creation?

Ross : I joined State Street in July 1992, and got involved with SPY shortly thereafter. But I have to say there were a lot of folks involved with it, including the folks from the asset-servicing side, trying to figure out how to make creation/redemption—and things that we look at today as being straightforward—work. Making them work for the first time was anything but straightforward!

IU.com:What inspired the idea to come out with a product like SPY? And on that, what were some of the other products that evolved from Nate Most’s original concept?

Ross : The original concept was based on what they called “warehouse receipts,” and the question was whether there was a way to take those and have them list and trade on an exchange as well as be asset backed. That was a key consideration. In other words, the concept really was to have something that was asset backed that was able to trade at fair value, or as close to fair value as possible in multiple market conditions. In positive conditions and in times of stress, no matter the market environment, we wanted to make sure the underlying information was known at all times, and that people could make markets of it.


IU.com:Was that a hard initial sell? How did you first introduce an ETF to investors?

Ross : Well, it took a lot of education. But the concept was based around indexes, and for SPY, giving people broad access to the S'P 500. It made sense. Index investing wasn’t a totally new concept at the time.

IU.com:And from SPY to 1,400-plus ETFs in a short 20 years.

Ross : I can tell you that Nate’s view initially wasn’t that there would be thousands of ETFs. That’s for sure. His original vision was that there was a potential for having maybe five ETFs in the market.

IU.com:From the get-go, what was the expectation in terms of asset gathering? Did you ever envision it as a $120-billion-plus fund?

Ross : I’m not so sure. There were concerns about whether SPY would trade and people would invest in it. We all put a significant amount of energy into getting it launched. There were some questions as to whether this was going to have any longevity and be successful.

The original prospectus language noted that if the product didn’t reach a certain size, it would be shut down and all sorts of things—language that looks almost silly in a product nearing $130 billion in assets, and one that was the main asset-gathering ETF last year and continues to grow. But we had no idea it would get to where it is today.

IU.com:Was there a turning point when you knew SPY would stick around for good?

Ross : There was probably a point in 1995 or 1996 when we started to see more traction and more trading, and we started to be more comfortable that this product would stay. Once it got traction, it hit a point for a number of years in the late 1990s when it just doubled in size every year. It had a number of years when assets were growing at 100 percent. That’s obviously not sustainable, as you get bigger, but it’s still impressive.

IU.com:What was the catalyst that made the fund turn the corner and take off in terms of assets?

Ross : It took a significant amount of investor education in the early days. No question about that. And the education was more focused on the trading and institutional community, which was the target audience for the original ETFs.

ETFs were much more focused on being a liquid traded product than anything else. If you think about the reason for them, it all came from the American Stock Exchange, with the goal of having this product be listed and traded, without as much of a focus on asset gathering. To a certain extent, there’s a correlation between rising assets and tradability, but the focus was really on the trading aspect of SPY. All of the early marketing materials were really focused on educating traders and institutional investors on how they could use SPY as an alternative to futures, and things like that. And truth be told, it took a while for that education to work.


Ross (cont'd.): Eventually, you started to see new ETFs come in—in 1998, you saw the Diamonds and the Sector SPDRs, and then came the “Q’s” and the word about ETFs started to pick up steam. But education was really centered on trading at the outset. In fact, the financial advisor community, which is now a big piece of the ETF business today, was not a focus in the early days at all.

IU.com:It seems that what started as a trading concept evolved into something that is largely perceived as a good long-term buy-and-hold instrument today.

Ross : You are right that in the early days people looked at SPY as a liquidity product and a trading product, but when it was built, there was a lot of focus on ensuring that SPY could house and be a good product for investors who wanted long-term and short-term tools. When I think of some of the core principles around SPY, one of them is the fact that you can have people trade it all day long and have people create and redeem every day, and this trading does not negatively impact the shareholders in the fund who chose to buy it in 1993 and hold it until today.

From a structural standpoint, this was the first time that idea really worked. If you think about mutual funds, cash redemptions are troubling for them, and they don’t like fast action from an asset standpoint, so that’s always been problematic from that perspective. And in closed-end funds, you have the trading aspect, but you don’t have the ability to meet the demand for growth of assets and decline of assets to trade close to fair value at all times.

IU.com:Talking about structure, do you think that SPY, as a unit investment trust that can’t reinvest dividends, is in any way flawed for today’s investor needs? Does that limit the fund at all?

Ross : I don’t think it limits the fund at all. Actually, it helps it track the index in a pure way, which folks who use SPY as an alternative to futures really appreciate. It allows SPY to track tighter to the actual S'P, where reinvestment of dividends can cause other issues. That’s a structural issue of the UIT that I don’t think anyone is really worried about, to be honest. At $130 billion, I feel pretty good that it’s not hurting it too much.

IU.com:Fair enough. In a way, index investing was already widely used by many investors, but SPY introduced tradability to that space. Do you agree?

Ross : Yes. And simplicity, to a certain extent—the ability to put it all in one wrapper.


IU.com:As you look back, is it surprising to you in any way to see that SPY kicked off an ETF revolution that’s still gathering steam? It’s pretty impressive.

Ross : It is! Coming on SPY’s 20 th anniversary, I’ve been thinking a lot about how far it’s come. The broad implication of it is that, in the end, yes, we wanted to be a part of it, but it’s not about State Street or Amex; it really is about helping investors. ETFs have helped investors manage their risk and their portfolios, and invest in a way where they have broad diversification in a very timely way. That piece is one of the things we’re most proud of.

IU.com:What helped push ETFs to the next level?

Ross : I think part of the success of the ETF is tied to the emergence of the online brokerage, and the emergence of an advice platform that turned to a fee-for-service platform. When you think about the financial advisory world and go back 20 years, the large broker-dealers and the financial advisor community were not embracing ETFs because their revenue model was built on stock trading. With SPY, you trade once and you get the diversification of 500 stocks, so it wasn’t beneficial to them.

When you think of all the stars aligning to allow for the growth of ETFs, it’s clear that technology helped propel the industry. You have the advent of online brokerage accounts, you have lower commissions, which have helped, and you have the emergence of a new way of advisors managing their clients’ wealth and doing it in a manner that they still get compensated, but in a more transparent fashion to the end investor. These developments aren’t really ETF-related, but they have helped propel the ETF in the marketplace.

IU.com:Looking at where the ETF industry is today, what do you see the next 20 years looking like for ETFs?

Ross : That’s a tough question. We see continued innovation. Active ETFs are going to, over the long term, be very successful. But it’s hard to say what types of products will emerge. Is there something new and more innovative that will emerge and have us look at ETFs in a different way?

With what we know today, ETFs have been successful because they have helped investors solve their investment challenges, and I think we are going to see increased use of ETFs. I think that’s still in its early days, even 20 years later. There are still folks who are using only one ETF who might in three to five years be using 10 or 15. Prospects for future growth from that perspective are still very strong.


IU.com:Should we expect SPY to be as relevant in the next phase as it has been in the past?

Ross : I think SPY will certainly be relevant in the next phase of ETF industry growth. I always think about the possibility of the emergence of another new product, as in something coming in and being totally innovative. But I think ETFs and traditional mutual funds can and will coexist for a long time. But in the index space, ETFs have created the better mousetrap, and the growth trajectory has proven that. Is there something else in the future that’s going to have us looking at ETFs in the manner in which we look at index mutual funds today? You never know.

IU.com:Is there anything that stands out in your mind as something you’re particularly proud of when it comes to SPY?

Ross : I think it’s the fact that we—as in State Street and everyone else who was involved with this—all took a risk. The original prospectus language outlining those risks really meant something in those early days; there was no guarantee that this product was going to be successful or even trade. There was no certainty of success. The fact that it has grown, and expanded and really helped investors invest while lowering their costs as well as diversifying their portfolios in ways that were not available 20 years ago is truly an accomplishment.

From a broad ETF standpoint, that’s the hallmark piece of it:The benefits of the ETF have become ingrained into the investing public. And I tell you, if you want a prediction, I think in the next 20 years, the regular “mom and pop” retail investor is going to know of ETFs in the same way they know of mutual funds today.

IU.Com:How will you celebrate? Anything special planned?

Ross : You bet! We are doing a few events to mark the occasion. On the Jan. 29, we are doing Closing Bell and an event in New York, and simultaneous events around the globe where SPY trades. We are looking at this as a global celebration and we are very excited about it.


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