After 30 Years, the King of ETFs Faces a Fight for Its Crown

Known by everyday investors and pros alike by its ticker symbol, SPY, the fund simply tracks the S&P 500 index of the largest US public companies, for a modest fee of 0.095% of assets per year. It’s the go-to product especially for institutional money managers who want a fast and dependable way to hop in and out of the market. But other ETFs follow the same index at a third of its expense ratio and have become a magnet for everyday investors. In the past year, BlackRock Inc.’s $302 billion iShares Core S&P 500 ETF and the $275 billion Vanguard S&P 500 ETF have added tens of billions of new assets while SPY posted outflows.

Even if SPY is overtaken, its place in history as the fund that changed both personal investing and the asset management business is secure. It wasn’t technically the first ETF—that distinction belongs to a Canadian product—but it was the first in the biggest stock market when its shares began trading in 1993 under the original name Standard & Poor’s Depositary Receipts, or “spiders.” In an echo of its challengers today, the new fund upset plenty of established businesses.

First and foremost, it was a passive index fund. In the early 1990s, these were still fairly novel—they accounted for less than 2% of US fund assets, according to Investment Company Institute data, compared with close to half today. While Vanguard founder Jack Bogle was evangelizing the virtues of low-cost indexing, the biggest stars of the mutual fund business were the stockpickers at places such as Fidelity, T. Rowe Price and Templeton. Investment products commonly carried hefty upfront sales commissions to compensate the brokers who hawked them, and equity funds carried average annual expenses of more than 1.4%.

The ETF was also a totally new way to buy funds. Investors in mutual funds could only get in and out once per day, at a price reflecting the of the portfolio at the close of market. People often mailed checks to fund companies to get their shares. But SPY, developed by the American Stock Exchange and Boston-based State Street Global Advisors, could be traded instantly like a stock by anyone with a brokerage account. Investors could even short it—that is, bet on its price falling. Making all this work wasn’t simple. Specialized traders would have to step in to make sure the price of SPY’s shares more or less matched the of its portfolio of stocks; they’d make money by exploiting the tiniest gaps in prices. This is still how ETFs operate today.

Jay Baker was vice president of options marketing at the American Stock Exchange at the time of SPY’s launch and was given the job of drumming up business for the ETF. On one call, a broker-dealer said he loved and owned the product but hoped Baker would fail, and added that he wasn’t welcome in the office anymore. “As far as I’m concerned, that was the turning point, the hostility of that phone call,” says Baker. “I said, ‘This is gonna be successful because we never get a reaction like that.’” It was a threatening product, he says, because many firms sold S&P 500 portfolios to their clients for a much higher fee.

Small investors didn’t immediately switch from mutual funds to ETFs, because brokerage costs on each trade could swiftly eat into small incremental investments. But as online trading became commonplace and commissions plunged toward zero, ETFs eventually became the quickest and easiest route to a diversified portfolio. Vanguard launched its own ETFs, and BlackRock acquired the manager of the iShares ETF line to become the biggest asset manager in the world. Today there are about 3,000 US-listed ETFs and counting, and the competition has helped pull down costs everywhere. Fidelity, the home of some of the 1990s’ hottest active funds, now sells some traditional index mutual funds with a doorbuster expense ratio of 0%. “Think about what ETFs have done for investors over the last 30 years,” said Jillian DelSignore, head of adviser sales at fintech platform FLX Networks and an ETF industry veteran. “It’s provided access, it’s democratized that access for so many different types of exposures. And SPY was No. 1.”

Investors are voting with their feet in favor of ETFs. Mutual funds as an investment class have posted net outflows for five years straight as ETFs gain assets. Seeing the writing on the wall, almost every major Wall Street player now offers the newer structure, and some are even converting mutual funds into ETFs. Once a synonym for passive investment, ETFs today include a number of actively managed funds. Cathie Wood’s ARK Innovation ETF, a concentrated portfolio of high-risk tech bets, became the avatar of the pandemic-era stock boom and bust.

Inevitably, the industry’s explosive growth has brought with it missteps, risky products and controversy. Besides the supercheap index funds tracking plain-vanilla equities and bonds, there are ETFs and related products such as exchange-traded notes offering everything from space exploration and cannabis stocks to leveraged bets on market declines and even wagers on the sheer volatility of markets. ETFs have sometimes been at the heart of global turmoil after helping bring too much cash to thinly traded areas like oil futures. Regulators have expressed concern that complex products are leading investors into danger.

Their incredible cash inflows—in particular to the huge passive vehicles—has even stoked concern about how ETFs may be affecting trading, as investors automatically pile into the same assets. Indexing proponents point out that there are still plenty of active traders to make sure that prices reflect new information and sentiment. Meanwhile, BlackRock, Vanguard and State Street have become top shareholders in most major American companies, raising questions about the potential impact on corporate governance and the power of fund companies in proxy votes.

One reason SPY is facing competition for the title of biggest ETF is the democratization of investing that it kicked off. Much of the money pouring into BlackRock’s and Vanguard’s S&P 500 ETFs comes from retail investors. That includes investments via so-called model portfolios—off-the-shelf strategies containing ETFs and mutual funds that are mass-marketed by advisers.

SPY has one remaining advantage, and it’s a big one: how much it trades. While buy-and-hold investors want the lowest fees, there’s another group of traders who need to move faster and who don’t hold their ETFs as long. Institutions making tactical adjustments frequently turn to SPY because its shares are so liquid, meaning for every seller there are more buyers and vice versa. That means the spread, or transaction cost, on each trade is much narrower, which is more important to them than the annual expense of the fund. The liquidity is enhanced further by supply and demand generated by a huge universe of options tied to SPY and the lending market for its shares, where participants are continually hedging portfolios or making bets on whether the ETF will rise or fall.

That all makes SPY the most traded security in the world, with average daily volume of $39 billion. As the tool of choice for short-term portfolio adjustments, its volume can explode at times of crisis. When Covid-19 struck in 2020 to trigger broad market panic, it was the first ETF in history to trade $100 billion of shares in a day. In an era of declining liquidity, that means that even if it loses the asset crown, SPY can reign among traders for years to come.

“People are confident it will be there,” says Reggie Browne, the co-global head of ETF trading and sales at trading firm GTS. “You have 30 years of empirical evidence of how SPY has behaved.”

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