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The S&P 500 index has become the most widely-used representative for the performance of the US market. Unlike the Dow Jones, which is focused on just 30 US blue chips, the S&P 500 measures the performance of the 500 largest companies listed in the US.
The index includes a diversified range of established names such as Johnson & Johnson and Proctor & Gamble, but recently it has become increasingly dominated by higher growth technology companies such as Amazon, Netflix and Alphabet. The strong performance of the FAANG stocks has left it with a significant skew to technology. At just under a third, it is the largest sector in the index. The next two being healthcare and consumer discretionary.
Over the past decade, the S&P 500 has outpaced all of the other major global indices, delivering an average annual return of 14.45%. Its fortunes from here depend on sentiment towards the technology sector and the US market. Find out why investors choose to invest in S&P 500 ETFs, the difference between active and passive investing and some S&P 500 ETFs.
Why choose to invest in a S&P ETF?
One of the main advantages to investing in a S&P ETF is that it’s passive rather than active. We’ve compared active and passive investing to help you understand.
Active vs passive: what’s the difference?
Over the years, research has shown that it is difficult for active managers to outperform the wider index, but this is particularly hard in the US market, which is the largest and most liquid in the world.
The S&P Indices vs Active (SPIVA) scorecards are semiannual scorecards published by S&P Dow Jones Indices. They compare the performance of active equity and fixed income mutual funds against their benchmarks over a number of time horizons. The most recent scorecard showed the S&P 500 beat over 70% of active funds over one year, 71% over three years and 79% over five years.
With this in mind, investors across the world have tended to prefer to invest in passive vehicles, such as the S&P 500 ETFs, for their exposure to the US market. Funds tracking the S&P have grown to become some of the largest passive funds in the world.
What are the advantages of ETFs?
- Lower fees. Three of the top five ETFs in the world are based on the S&P 500 – from Vanguard, iShares and State Street. Between them, they hold US$678 billion. Each of them has a low ongoing fee, making them one of the cheapest ways to get diversified exposure to the US market.
- Low minimum investment. Depending on the brokerage platform, you may only need as little as £50 to get started.
- Quick decisioning. ETFs have daily pricing and can be bought and sold during trading hours. This is different to mutual funds, which only trade once a day and where the sale price may not be clear. This means ETFs can be useful for taking quick decisions.
Major S&P 500 ETFs in the UK market
The ETFs in the UK are split evenly between those that employ physical replication of the index and those that use synthetic replication. With physical replication, the ETF issuer will hold the shares in the proportion they are held in the index; with synthetic replication, the ETF issuer uses a derivative to deliver the performance of an index. Synthetic replication is generally more expensive but is seen as more accurate.
- iShares Core S&P 500 UCITS ETF. This ETF uses physical replication. The fund is the largest in the sector, at US$28.87 billion.
- Vanguard S&P 500 UCITS ETF. This ETF uses physical replication and has assets of US$19.60 billion.
- iShares Core S&P 500 UCITS ETF. This fund uses “optimised sampling” rather than full physical replication. It has an expense ratio of 0.07% and assets of US$8.12 billion.
- Invesco S&P 500 UCITS ETF. This ETF uses synthetic replication. Its expense ratio is 0.05% and the fund was launched in 2010. It holds US$6.69 billion in assets.
- Xtrackers S&P 500 Swap UCITS ETF. This ETF uses synthetic replication and has an expense ratio of 0.15%. It is US$5.04 billion in size and was launched in 2010.
- SPDR S&P 500 UCITS ETF. State Street runs the largest ETF in the world, but its UK equivalent is smaller at US$3.46 billion. It has an expense ratio of 0.09% and was launched in 2012. It is a physical replication ETF.
- HSBC S&P 500 UCITS ETF USD. This HSBC ETF has an expense ratio of 0.09% and uses full physical replication. It was launched in 2010 and holds US$2.93 billion in assets.
- Amundi ETF S&P 500 UCITS ETF USD. This Amundi ETF has an expense ratio of 0.15% and employs synthetic replication. It was launched in 2018 and has US$2.54 billion in assets.
- Lyxor S&P 500 UCITS ETF – Dist (USD). Lyxor uses synthetic replication for this ETF. It has an expense ratio of 0.15% and was launched in 2010. It has US$2.28 billion in assets.
- Lyxor S&P 500 UCITS ETF – Acc. This is the “accumulation” option of the Lyxor ETF. It also has an expense ratio of 0.15%, but it was launched in 2014. It has US$1.35 billion in assets.
What drives the S&P 500?
The key driver for the S&P 500 is the health of the US and global economy and investors’ appetite for taking risk. That said, the S&P 500 has some specific nuances. The top five US companies in the S&P 500 are all the major technology names. The weighting varies, but Apple, Microsoft, Alphabet, Amazon and Facebook usually comprise around 20% of the total market capitalisation of the S&P 500. While the S&P 500 is a diversified index, its performance will be significantly influenced by these five names.
All stocks are influenced by monetary policy and the level of interest rates to some extent. In general, stock market indices will perform better when interest rates are low. This is particularly true for the S&P – the real beneficiaries from loose monetary policy are businesses with high earnings and fast revenue growth. These earnings become more valuable as interest rates fall. The S&P 500 has more of these fast-growing companies than many of its international peers.
The S&P 500 has a relatively low dividend yield, at around 1.6%. Again, this is influenced by the high weighting in technology names, which don’t tend to pay dividends. The market may value dividend stocks more highly at various points in the market cycle and this may influence pricing. There may also be more volatility around dividend announcements.
The biggest risk to the current performance of the S&P 500 is that investors lose their appetite for technology names. While the index has 70% in other sectors, technology companies have driven performance in recent years. Valuations are now expensive and there are threats to the sector in the form of higher regulation and political interference.
There is also a risk that investors lose their enthusiasm for the US market. It has outpaced other global markets for more than a decade, but political disruption and poor response to the coronavirus outbreak have seen the dollar slide and money move away from the US. Given that S&P 500 trackers are a popular means for international investors to gain access to the US market, they may suffer if sentiment turns.
There are other risks specific to ETFs. ETFs come with some counterparty risk. This is a greater risk with “synthetic” ETFs where there is an investment bank on the other side of the trade. That said, most ETFs have improved their risk management in recent years, bringing in more appropriate collateral in the event of default.
Equally, there are risks associated with passive investment. S&P 500 ETFs only replicate the returns from the S&P 500. If it falls, the ETF will fall with it. This is in contrast to active investments where a fund manager can move to cash, or switch holdings in a more difficult environment.
S&P 500 ETFs in summary
S&P 500 ETFs are an easy way to gain access to a diversified mix of US companies, including some of its most exciting growth companies. It has been a popular way to gain access to the US market, where active managers have struggled to perform better than the index.
The performance of technology companies has been crucial in this strong performance, as Facebook, Amazon, Apple, Netflix and Alphabet (owner of Google) – the so-called FAANGs – have grown fast and seen their share prices soar. However, changing sentiment towards the technology sector specifically and the US stock market in general will have an influence on its fortunes from here.
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