Twenty years after launching the SPDR S&P 500 ETF, State Street Global Advisors looked back last week on the birth of its flagship exchange-traded fund and re-examined the industry it helped spawn. A few ETF adherents, as well as those on the ground floor during the product’s humble beginnings, now say these funds not only changed investing, but the structure of the financial advice industry as well.
ETFs, which can trade baskets of equities intraday, like stocks, have been touted for their lower costs, the opportunities they present for tax-loss harvesting, their transparency and their close hewing to their underlying stocks’ NAV. They also offer opportunity to advisors to tailor aggressive asset allocation strategies, using highly diverse exposures to all sorts of investments. The product has revolutionized the investing world in many ways, said a panel of investors and ETF experts brought together at the St. Regis Hotel in Manhattan on January 29. One of those ways has been to allow both institutional investors like hedge funds and retail investors at home on their computers to grab instant access to indexes at the same time -- and for the same small fees.
“We like to say that the ETF has actually democratized the retail asset management market, and in essence we actually think it’s grown the pie,” said Pooneh Baghai, a senior partner at McKinsey & Co. who leads the firm’s North American Asset Management, Wealth Management and Retirement Practice.
Tom Lydon, the editor of the ETF Trends Web site, puts it even more pointedly: ETFs “are going to be the dagger in the heart of the [mutual funds] industry in 20 years.”
Since the ETF’s introduction in January 1993, fund companies have pushed far beyond the indexes into all sorts of esoteric ETF frontiers: inverse strategies, funds that handle commodities like gold and farmland … and now even active strategies.
The funds have become so ubiquitous that price wars have erupted in the now-crowded space among the other giant players like the current market leader, BlackRock’s iShares, which has cut fees as rival Vanguard has munched up market share with its own low-cost funds. By far, most of the ETF market's $1.3 trillion in assets, almost 88 percent of which are concentrated at BlackRock's iShares, Vanguard, State Street and Invesco's PowerShares, Lydon said. However, companies like Charles Schwab have also been aggressive players, as Schwab has slashed fees and waived commissions on these products for those who use its brokerage accounts. Lydon refers to this price war as a “race to the bottom.”
State Street launched the SPY fund on January 29, 1993, with $6.5 million, it said. (The fund holds more than $128 billion today.) Jim Ross, a senior managing director of SSgA and chairman of the Investment Company Institute's Exchange Traded Funds Committee, was on the team that co-created the SPDR in 1992.
“I joined State Street in July of 1992,” Ross said. “And about three months later, there was a bunch of folks working on something that I wasn’t involved in and they needed some help. ... I quickly became what was known as chief bottle washer in that group. Pretty much anything they needed done, I did.”
The company had to do a lot of back and forth at the time with the American Stock Exchange, where the product had its genesis with the late AMEX Vice President Nathan Most, who was seeking ways to “warehouse” the underlying securities in unit investment trusts and make them redeemable with in-kind transactions that wouldn’t harm the underlying NAV. State Street was amenable to this idea. Along with the AMEX and a battery of lawyers, the company worked with the SEC to get the approvals necessary for the product. State Street says it spent a lot of money on technology before the product was even approved. The original idea was experimental and not everybody was convinced the product would work. An earlier version had even been dumped by regulators. So the company wasn’t sure the new product would pass muster with regulators while it was building out the (expensive) plumbing for the product, according to a State Street brochure commemorating the anniversary, “SPY: The Idea That Spawned an Industry.”
“We were way, way over budget on [technology],” Ross said. “And there were lots of folks who were not sure this thing would ever work. I think some of the thing we come to look at as commonplace today—creation/redemption and how everything moves—trust me those first days we were not convinced.”