Yahoo Finance Happy 25th Birthday: The SPY ETF Changed Investing
Exchange-traded funds are a growing part of the investment landscape, with the SDPR S&P 500 Trust ETF (ticker: SPY) the biggest one of all. The ETF replicates the Standard & Poor's 500 index by holding all 500 stocks in one fund.
With $279 billion in assets under management, SPY is the biggest security traded globally. On average it trades 65.4 million shares daily. Compare that to the most widely traded stock in the U.S. stock market, Apple ( AAPL), which has an average daily volume of 28.6 million.
Popular with retail investors, financial advisors and institutional traders, the SPDR S&P 500 Trust wasn't always such an equity behemoth. It launched on Jan. 22, 1993, to some initial interest, but when the ETF celebrated its first birthday, it had more outflows than inflows. By 1995, though, the fund had gained traction, and eventually an entire industry developed. ETFs now represent 7 percent of the total investable U.S. equity market, and globally ETFs represent $4.3 trillion of investment dollars, according to State Street Global Advisors, citing Morningstar data.
[See: The 10 Best ETFs to Buy for 2018.]
The first ETF is born. Jim Ross, executive vice president of State Street Global Advisors and chairman of the global SPDR business, which issues the ETF, says SPY emerged from the ashes of the 1987 stock market crash. After reviewing the causes of the market crash, the Securities and Exchange Commission began looking for ways to mitigate another plunge. "The SEC noticed the stock market did not have a single security that represented the broad market, similar to what the futures markets have with futures contracts," Ross says. "And the SEC concluded if it had, that damage could potentially have been minimized and perhaps avoided entirely. That was the message they sent to the industry."
Ross says the SEC made a broad request to the industry to design a single-security product that represented the underlying assets, similar to futures contracts. The product development team at the now-defunct American Stock Exchange came up with a security that could withstand a crash similar to the one in '87.
The security was a unit investment trust that worked much like the futures market concept of warehouse receipts. In the futures market, warehouse receipts show ownership proof of a commodity, and rather than moving physical product, traders exchange receipts. Instead of commodities, the new security would hold stocks in the unit investment trust, and these could be traded intraday on an exchange. Unlike futures contracts, which use leverage, the trust would be fully collateralized with the underlying asset, Ross says.
The American Stock Exchange approached State Street with the idea in 1990, Ross says, but three years passed before it came to fruition because of discussions with the SEC. When the ETF finally launched in 1993, some institutional firms traded it, but Ross says the SPDR, or "spider" as it was called, wasn't a huge success in the beginning.
[Read: How to Choose the Best ETFs to Buy.]
Will Rhind, chief executive officer of GraniteShares and an ETF industry veteran, says ETFs were not accepted immediately. "The prevailing view was that this was a fad, something that would never really gain widespread adoption," he says.
Technology paves the way to acceptance. But starting in 1995, the spider grew legs, with the ETF hitting its first billion in assets under management that year. A big reason for that was improvements in technology, which was changing trading in general, says Wade Guenther, portfolio manager at Horizons ETFs (U.S.), which is part of Mirae Asset Management. With DSL lines, data could be sent over existing phone lines in seconds, transmitting stock price information instantly and much more cheaply than before.
Technology helped pave the way for ETFs to become an investment vehicle for retail investors and financial advisors, rather than just institutional investors, the original intended user. Kevin Quigg, chief strategist for Exponential ETFs and former head of SPDR ETF global sales strategy, says 25 years ago it was much more difficult for the average person to access the stock market. "It was expensive to buy and sell stocks because the bid-ask prices were very high," Quigg says. "You needed to have a financial adviser to have access to an exchange. The barrier to entry was just a lot higher for people with respect to the stock market."
Cheaper technology led to the growth of online brokerage firms like Charles Schwab, E-Trade and others, Quigg says, making trading more accessible to the masses. Because the SPY ETF essentially represented blue-chip stocks, it was easy to understand. "It wasn't particularly complicated or delivering something particularly exotic," he says "
Guenther says after a few years, when competition arrived from iShares, now owned by BlackRock, the industry was established. "It took technology to make the concept work, and then it took investors to believe in it and put assets in the fund for validation," he says. "And then it takes other companies to enter the market for competition to further that validation, and then it's off to the races from there."
Although ETFs are grabbing market share from mutual funds and single stocks, Rhind and Quigg say they're still not as well-known as those other investment vehicles. "I mean I still I still go to cocktail parties and people say, 'what do you do,' and I say, 'I own an ETF a company,'" Rhind says. "They say 'what's that?'"
ETFs still have more new ground to break. Quigg notes ETFs generally aren't part of 401(k)s, which is how most retail investors without a brokerage account access the stock market, but he says there's an impetus to change that.
[See: 8 Great ETFs That Hold ETFs.]
With the growth of the industry over the past 25 years, it is possible to use ETFs to manage entire investment portfolios, which is what some institutions do. "ETFs need to deliver different solutions for different people," he says. "We're kind of getting there right now, but we're still not all the way there with respect to what the vehicle can do and who is entering the marketplace."
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