Spy, First U.S. ETF, Leads Industry it Started Even as Rivals Gain Ground

The first U.S. exchange-traded fund turned 30 this week, facing growing competition in the industry it leads. The SPDR S&P 500 ETF Trust (SPY) has accumulated $375 billion in assets to put it at the pinnacle of a $9 trillion global industry that's reshaped the investing landscape -- even as rival funds from BlackRock and Vanguard gain ground.

In recent years, exchange-traded funds, which can be traded during market hours and offer tax advantages over mutual funds, have attracted the lion's share of incremental investment capital. Amid last year's grinding bear market, global ETFs garnered inflows of as much as $867 billion, even as more than a record $950 billion exited mutual funds.

While U.S. mutual funds still hold roughly three times the assets of ETFs thanks to their head start and stranglehold on 401(k) plan investing options, ETFs have momentum and have already surpassed mutual funds in market relevance. With less than 13% of U.S. equity assets last year, ETFs accounted for 32% of trading volume, up from 25% in 2021.

SPY needed three years to reach $1 billion in assets, 16 more years to grow to $100 billion, and then less than five years to double that by 2016. Along the way it got plenty of help in popularizing ETFs from new ones reflective of their times, including the Invesco QQQ Trust (QQQ) launched in 1999 amid the dotcom bubble and the 2004 debut of the SPDR Gold Trust (GLD) in the early stages of a commodity boom.

"SPY gave birth to an industry that has democratized investing, giving investors large and small access to institutional-grade solutions that offer efficient, cost-effective exposures to all corners of the global investment market," said Rory Tobin, head of State Street Global Advisors' Global SPDR ETF unit, in a news release celebrating the 30-year anniversary of the ETF's launch.

Investors have flocked to low-cost ETFs in part out of disappointment in the performance of actively managed funds, which have performed significantly worse than benchmark indexes in recent decades. A study by S&P Dow Jones Indices concluded that not a single actively managed stock or bond fund out of more than 2,100 outperformed the market "convincingly and regularly" over a five-year stretch.

While low-cost, index-tracking ETFs have taken business from mutual funds and active managers, the growth has brought its own challenges. Leveraged ETFs have proven costly for investors unaware of their risks. Meanwhile, most of the more than 3,000 U.S. ETFs have struggled to increase their assets and trading volume in an industry made up of a few heavyweights and lots of welterweight longshots, The top 10 ETFs account for nearly 30% of industry assets and the top 25 ETFs for 40%, while the median fund has assets of just $90 million.

At the same time, BlackRock and Vanguard are attracting sufficient ETF inflows to extend their dominance. "In the ETF industry it's BlackRock and Vanguard, and those two are going to rule the land like King Kong and Godzilla unless regulators intervene," said Eric Balchunas, senior ETF analyst at Bloomberg.

BlackRock has $10 trillion in assets under management, the most in the world, and is the top provider of ETFs. Vanguard has expanded its business from low-cost mutual funds to even less expensive ETFs, and continues to get a reputational boost from the legacy of founder John Bogle. Balchunas, the author of The Bogle Effect as well as The Institutional ETF Toolbox, has written that SPY started at an expense ratio of 0.20% to match that of the Vanguard 500 Index Fund.

These days, SPY's gross expense ratio, at 0.0945%, is still more than three times the 0.03% cost of BlackRock's iShares Core S&P 500 ETF (IVV) and the Vanguard S&P 500 ETF (VOO). As a result, these ETFs are gaining on SPY in terms of assets. VOO and IVV had inflows of $40 billion and $21.5 billion respectively last year, while SPY saw outflows of $12.4 billion.

"SPY is going to be passed, and it could happen as early as next year but I'd be willing to bet by no later than 2025," Balchunas said. How soon it happens will depend on market performance since stock gains would favor SPY, which currently has a $76 billion lead on IVV and has nearly $100 billion more in assets than either VOO or the Vanguard Total Stock Market ETF (VTI).

It will take longer to erase SPY's advantage in liquidity and wide use in derivatives, since its trading volume is vastly larger than that of either VOO or IVV. But asset flows for similar products tend to benefit those with lower expense ratios and the ETFs with most assets ultimately gain trading market share, according to Balchunas.

He said State Street (STT) may ultimately sell its ETF business to a buyer who might benefit from greater synergies. JPMorgan (JPM) and Morgan Stanley (MS) have muscled into the ETF space recently, but despite their size neither Wall Street giant can hope to become more than a niche player in the industry, Balchunas said.

"There's going to be a lot of action, consolidation, and experimentation in the industry," Balchunas said. "The two paths for success in ETFs are going to be cheap or shiny."