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The 6 Best Passive Large-Cap ETFs

Passive large-cap funds won the performance battle in 2014.

Michael Rawson, CFA, 01/30/2015

The S&P 500 outperformed 80% of active managers in 2014 and beat the small-cap Russell 2000 Index by more than 8 percentage points. Strong fund flows reflected investor preference for large-cap funds as the three exchange-traded funds with the strongest flows in 2014 each track the S&P 500, an index of large-capitalization stocks. While the S&P 500 is the most popular, it is not the only large-cap index that investors can choose.

A total stock market index fund is usually the most efficient way for index investors to get exposure to the U.S. stock market because they offer comprehensive coverage of the market with very low turnover. However, there are at least two scenarios where it could make sense to hold separate size segment funds. They could be appropriate for investors who want to give an overweighting to certain size segments, such as small-cap stocks, when they believe that segment will outperform. However, it is very difficult to consistently get these calls right. Because different size segments tend to exhibit different risk and return characteristics, investors could also use these funds to exercise more control over their strategic portfolio allocations. In addition, investors may use size segment funds to balance out a portfolio of active managers.

The chart below illustrates the annualized volatility and return for stocks sorted by market capitalization and grouped by quintile dating back to 1926. While smaller-cap stocks have generally offered higher returns over the very long term, there have been several market cycles that favored different size segments. The S&P 500 beat the Russell 2000 each year from 1994 through 1998, but that reversed in each year from 1999 through 2004.


  - source: Morningstar Analysts

There is no industry-agreed-upon definition for large cap, so each index provider defines the large-cap universe in its own way. Morningstar defines large cap as all of the largest stocks, which in aggregate make up 70% of the market value of all stocks; this currently corresponds to stocks with a market cap larger than $17 billion. In terms of index performance, it’s a statistical dead heat. Because the indexes have similar risk and return profiles, the choice of which ETF to use largely comes down to factors such as fees, liquidity, tax efficiency, and personal issues such as which brokerage platform is used or how the other assets in the portfolio are positioned. 

There are 11 ETFs that track market-cap-weighted passive indexes, excluding mega-cap and total stock market funds that also land in the large-blend Morningstar Category. In terms of fees, they charge between 0.04% and 0.20%. While these fees are low relative to the average large-blend mutual fund, which charges 1.1%, there is no reason to pay more than necessary. We can eliminate the funds charging 0.20%. In fact, it is somewhat odd that iShares is willing to charge just 0.07% for iShares Core S&P 500IVV but charges 0.15% for iShares Russell 1000 IWB, which offers similar exposure.



The expense ratio is just one aspect of cost. Trading costs also have an impact on total return. While the underlying stocks in each of these indexes are mostly the same and are all liquid, some of the ETFs with fewer assets trade less and have wider bid-ask spreads. For example, the iShares MSCI USA EUSA has just $57 million in assets and trades less than $1 million of volume a day. The average bid-ask spread of 17 basis points would quickly eat into the returns of a frequent trader. In contrast, SPDR S&P 500 ETF SPY trades more than $20 billion a day, and its bid-ask spread is frequently less than 1 basis point.

Michael Rawson, CFA is an ETF Analyst with Morningstar.
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