Know What You Own, Part 3

BCR Wealth Strategies |

Our final installment of Know What You Own is a perfect illustration that you cannot make assumptions based on the title of a fund.

You can’t find a less expense or more simplistic equity fund than an S&P 500 index fund.  The two tickers above, SPY & VOO do just that:  Mimic the S&P 500 index.

SPY is one of the most popular and liquid ETF’s available.  Vanguard wrote the book on index funds.  But if you dig just a little bit you find some startling differences worth considering.

First, SPY cost 9.5 bps and VOO costs 3 bps.  While 6 bps in savings won’t wreck your retirement plans, why pay 3x for the same thing?

The next key difference could be profound.  SPY is legally classified as a unit investment trust.  This means there are some rules it is subject to that VOO is not.  This could potentially prevent SPY from achieving auxiliary returns VOO can seize.  Some examples are:

  • SPY cannot engage in securities lending
    • This is when a fund loans out shares of different securities it owns so that short sellers can attempt to profit from a price decline that they are expecting
    • When you loan these shares, you are compensated for the loan in the same way a bank is compensated in interest on loans it provides
    • The fund that earns interest from loaning securities can return these lending profits to shareholders
  • SPY cannot use index derivatives
    • This means that it cannot use futures or options, even in small amounts, in an attempt to drive higher returns. 
  • SPY cannot reinvest dividends issued by the constituent securities of the fund.

VOO can and does engage in all three of these activities in pursuit of higher returns. 

Let’s look at historical performance to see if these other activities provide additional value:

  • YTD
    • VOO – 8.07%
    • SPY – 8.16%
  • 5yr
    • VOO – 83.08%
    • SPY – 82.62%
  • 10yr
    • VOO – 287.93%
    • SPY – 285.43%

So, while these practices may not produce an edge over 8 months, there is a slight edge over longer time frames.  And while it is very small, it’s like the expense question:  If I’ve got two apples and one cost 3x more, why would I buy the expensive one?

In this three-part series, we’ve seen several examples where knowing what you own provides perspective on your investment portfolio that can really provide you long-term value.  The three main themes we examined were:

  • Blindly following a newsletter recommendation to save money on fund expenses resulted in an unknowingly massive shift in what you are invested
  • Assuming that commercial real estate is all bankrupt retailers and empty offices can cause you to miss out on returns from high quality cell phone tower and data center firms
  • And even something simple like two very well-known S&P 500 index funds can have structural differences that can prevent one from earning extra returns over time

One of the big advantages of public market investing is well-regulated transparency.  But you still must have the initiative to understand what you own.  Or at least ensure the person responsible for managing your investments understands the intricate differences we’ve illustrated over these examples.