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Fund Spy

SPDR S&P 500 Is A Good ETF That Could Be Better

Despite being the oldest ETF, SPY isn't the best choice for large-cap exposure, says Morningstar's analyst.

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The first-ever exchange-traded fund listed in the United States, SPDR S&P 500 ETF Trust (SPY) boasts a broadly diversified portfolio that’s generally representative of the investment opportunity set available to its Morningstar Category peers. 

However, its unit investment trust structure limits managers’ ability to eke out incremental value for shareholders and its fee is a multiple of those charged by its closest peers. This fund earns a Morningstar Analyst Rating of Silver.

The fund tracks the S&P 500, which represents the U.S. large-cap opportunity set in a cost-efficient way. S&P’s eligibility criteria require index constituents be profitable and highly liquid. While most large-cap names are financially viable, the requirement ensures that occasional exceptions are kept out of the index, improving the portfolio’s risk profile. An index committee selects the shares of 500 companies that meet these criteria, which collectively represent approximately 80% of the total market capitalization of U.S. stocks. While the index’s committee-based approach to stock selection sacrifices transparency, it provides more flexibility around reconstitution and can reduce unnecessary index changes.

The U.S. large-cap market enjoys a high level of information availability and liquidity. New information is quickly reflected in stock prices. Market-cap weighting leverages all the hard work done by other market participants to determine each stock’s weight in a cost-efficient manner. This approach promotes diversification and lowers unnecessary turnover.

However, market-cap weighting may expose the index to significant stock- or sector-level concentration during the market’s intermittent frenzies. This can tilt the portfolio toward richly valued names or sectors, such was the case during the late-1990s technology bubble. In the long run, the benefits of broad diversification, low turnover, and a low fee outweigh these drawbacks.

Lan Anh Tran does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.