Three ETFs to crack the US

The United States stock market is the biggest in the world, with a 37 per cent share of the world's equity market capitalisation. One of the best ways for investors to get exposure to it is through a broad-based exchange-traded fund (ETF).

Renowned stock picker Warren Buffett has for many years recommended that investors buy into low-cost S&P 500 index funds – such as ETFs – and it's with good reason. Over the past 10 years, the S&P 500 index has outperformed over 80 per cent of active fund managers.

In his most recent shareholder letter, the billionaire investor wrote about one of his own investing heroes, Vanguard's Jack Bogle, whom Buffett believes has done more for American investors than anyone else. For decades Bogle has encouraged investors to invest in ultra-low-cost index funds, and today millions of Americans are better off because of it.

The big three

In this review, we will examine three of these ultra-low-cost ETFs from ‘the big three' providers: State Street Global Advisors, Blackrock, and Vanguard.

State Street's SPDR S&P 500 ETF (ASX:SPY) was the first ever ETF launched in the US in 1993, and is the world's largest ETF with $US242 billion of assets under management. It is also the most frequently traded ETF, with over $US16bn of shares traded daily. To many hedge funds and day traders, this is the only ETF they trade as it replicates the benchmark with near perfect precision.

Blackrock's iShares Core S&P 500 ETF (ASX:IVV) is the second-largest ETF in the world and was launched in 2000.

The Vanguard S&P 500 ETF (NYSE:VOO) is the fifth-largest ETF in the world and was launched in 2010. It is listed on the NYSE Arca exchange (headquartered in Chicago), but is not listed on the ASX.

The similarities

As can be seen in Table 1, there are many similarities between the three ETFs. They all track the S&P 500 Index, which accounts for around 80 per cent of the total market capitalisation of the US equity market.

All three ETFs have low management fees, which enables them to track the index closely. Blackrock's IVV ETF has the lowest fee at 0.04 per cent.

The low fees are possible due to the size of the ETFs. A small percentage fee of an extremely large fund is still enough to cover fixed costs, and provide significant revenue for the three providers. The low fees also result in better performance, which in turn attracts more funds.

The low fee makes it near impossible for other ETF providers to compete directly on the same index, so they either create ETFs with slight variations, or track other indices or themes.

All three ETFs are large and liquid, and track the S&P 500 index closely. The ETFs provide a highly diversified portfolio of some of the best companies in the world, as can be seen in Table 2.

As a side note, if a company has various classes of shares, the S&P 500 will keep these separate. Alphabet Inc. (which owns Google), has Class A and Class C shares, which both sit just outside the top 10. If they were combined they would make up 2.45 per cent of the index and sit in third place.

The differences

Though all three ETFs look the same, under the hood there are some important differences.

Blackrock's IVV is permitted to lend out stock, which provides additional income – thought to be split 50/50 between Blackrock and the IVV fund. Although this provides additional income it also brings a small risk of loss in the unlikely event that any loaned shares are not returned. IVV is also able to reinvest the dividends it receives from its underlying companies until the dividend is ready to be distributed. This also enables an ever so slightly better return.

The SPY is structured as a unit investment trust (UIT), which is typically more tax efficient than a managed fund but can also be more restrictive. UITs, for example, cannot partake in stock lending or reinvest any dividends paid to them by their underlying holdings. The dividends need to wait in cash until they are ready to be distributed to SPY unit holders.

VOO's structure is slightly different again but, like IVV, it can lend out stock and reinvest its interim cash.

Conclusion

For investors wanting exposure to the US stock market, it is hard to look past these three ETFs.

All three are ultra-low-cost, run by top quality global ETF providers, and almost perfectly track the S&P 500.

It is hard to split which is best. IVV and VOO, with management fees of 0.04 per cent and 0.05 per cent respectively, will give you a marginally better performance due to the lower fees. IVV and SPY have the advantage of being listed on the ASX, so are easier to purchase.

With ETFs designed to track indices, and US markets near all-time highs, the other important consideration is whether now is a good time to buy into the US market or whether, given global market risks, it would be better waiting for cheaper prices down the track.

As far as ETFs are concerned though, all three are top quality, and could make up a core component of your international equities exposure.

Disclosure: InvestSMART holds the iShares Core S&P 500 ETF in several of its funds.