Five Twists On S&P 500 ETFs

by on October 27, 2009 | ETFs Mentioned:

The S&P 500 is one of the most widely-followed benchmarks in the world, a bellweather of the American economy that is included in the Index of Leading Indicators. Composed of 500 of the largest stocks listed in the U.S. (as well as a handful of non-U.S. companies), the S&P 500 has a weighted average market capitalization of approximately $80 billion, and includes companies across all sectors of the economy.

NYSEWith the rise of indexing as an investment strategy, it’s not surprising that S&P 500 ETFs are among the largest and most heavily traded. With a market capitalization of more than $57 billion, the SPDR S&P 500 (SPY) is by far the largest ETF, nearly $20 billion larger than its closest competitor. The iShares S&P 500 Index Fund (IVV) comes in at number four on the list with almost $21 billion in assets, meaning that U.S. investors have nearly $80 billion invested in S&P 500 ETFs.

SPY and IVV are by far the most popular ways to play the S&P 500, but they’re not the only game in town. There are a number of exchange-traded products that feature twists on the popular index, offering similar risk and return profiles, but in some cases outperforming the popular benchmark by a wide margin.

ProShares Credit Suisse 130/30 (CSM)

This ETF employs a 130/30 strategy that has been popular with investors for some time but is new to the ETF structure. CSM tracks the Credit Suisse 130/30 Large-Cap Index, a benchmark that establishes either long or short positions in certain of the 500 largest U.S. market cap equities by applying a rules-based ranking and weighting methodology. This fund essentially establishes a 100% long position in the S&P 500, sells short 30% of the holdings expected to underperform, and uses the proceeds to establish another 30% long position.

Because the end result is 100% net long exposure, CSM maintains a similar risk and return profile to the S&P 500, but uses quantitative analysis to attempt to beat the benchmark. CSM is a relatively new fund, but is certainly off to a hot start. Since its inception in July, CSM has gained almost 21%, about 100 basis points more than SPY over the same period.

RevenueShares Large Cap Fund (RWL)

RWL is one of four ETFs from RevenueShares that maintains similar holdings to popular market capitalization-weighted indexes but uses top line revenue (not market cap) to determine the weightings given to each holding. By using revenue to determine the weight given to each security, RevenueShares products invest more heavily in companies with a low price-to-revenue ratio and underweight those with a higher ratio. This strategy can also avoid changing allocations to companies based on corporate actions such as preferred stock redemptions, as happened with Citi earlier this year.

As shown below, weighting individual holdings by revenue can lead to a significantly different ETF composition (all weightings as of October 23, 2009).

Company SPY Weight RWL Weight
Exxon Mobil 3.7% 3.4%
Microsoft 2.3% 0.7%
Apple 1.9% 0.5%
JP Morgan 1.9% 1.3%
Procter & Gamble 1.8% 0.6%
Johnson & Johnson 1.8% 0.5%
General Electric 1.7% 1.3%
IBM 1.7% 1.2%
Chevron 1.6% 2.2%
AT&T 1.6% 1.0%

It is also interesting to note that Ford Motor Company is the second largest holding in RWL at 3.2%, while this stock makes up less than 0.3% of SPY.

PowerShares S&P 500 BuyWrite Portfolio (PBP)

This ETF is based on the CBOE S&P 500 BuyWrite Index, a benchmark that implements a “covered call” strategy on the S&P 500. Similar to 130/30 strategies, covered call funds are nothing new to investors, but a recent addition to the ETF industry (PBP was launched in December 2007).

The strategy implemented by this ETF consists of holding a portfolio indexed to the S&P 500 and selling a succession of options with an exercise price above the prevailing level of the S&P 500. If the S&P remains flat or rises slightly (to a level below the exercise price of the options), investors collect the premium on the options that expire out-of-the-money. Similarly, if the S&P falls, the premiums collected by the covered call strategy soften the blow.

The downside of this ETF strategy is its performance in a bull market. Because investors will be on the hook to those who took a long position in the written options, the upside potential of a covered call portfolio is limited. So PBP might be a good play for investors expecting a sideways market or looking to establish some degree of downside protection.

Rydex S&P Equal Weight ETF (RSP)

RSP maintains nearly identical holdings to the S&P 500, but as its name implies, gives an equal weighting to each individual stock (0.20% to each of the 500 equities). As of October 23, RSP’s largest holdings were in Gannett Co. (0.27%), (0.26%), and New York Times (0.25%). RSP’s top ten holdings account for about 2.5% of total holdings, compared to about 20% for SPY’s ten biggest allocations. The equal weighting strategy avoids one potential pitfall of market capitalization-weighted indexes: by giving each stock the same weighting, it is less likely to overweight overvalued stocks and underweight undervalued companies.

This strategy results in much bigger allocation to consumer discretionary stocks for RSP. This sector accounts for almost 16% of the equal-weighted ETF but only about 9% of SPY.

WisdomTree Earnings 500 Fund (EPS)

This ETF is based on the WisdomTree Earnings 500 Index, a benchmark that measures the performance of the earnings-generating companies within the large cap segment of the U.S. stock markets. To be eligible for inclusion in the index, companies generally must be incorporated in the U.S. and have positive earnings over their last four fiscal quarters. Larger weightings are given to the companies with the highest earnings.

Since not all components of the S&P 500 have positive earnings (particularly not over the last four quarters), the holdings of EPS may vary slightly. As of October 23, the ten biggest holdings of SPY all had material allocations in EPS as well, but the percentages varied significantly in some cases.

Company SPY Weight EPS Weight
Exxon Mobil 3.7% 5.4%
Microsoft 2.3% 3.1%
Apple 1.9% 1.2%
JP Morgan 1.9% 1.2%
Procter & Gamble 1.8% 1.2%
Johnson & Johnson 1.8% 1.4%
General Electric 1.7% 2.0%
IBM 1.7% 1.8%
Chevron 1.6% 2.9%
AT&T 1.6% 1.2%

Relative Performance

Most of the “tweaks” these ETFs apply to the S&P 500 seem relatively minor. But they can have a big impact on performance. As shown below, the year-to-date of these (note that CSM isn’t included since it was launched in July, but as noted above this ETF has outperformed the S&P 500 since its inception).

Ticker ETF YTD Gain
SPY SPDR S&P 500 ETF 18.5%
IVV S&P 500 Index Fund 18.7%
PBP PowerShares S&P 500 BuyWrite Portfolio 15.1%
RWL RevenueShares Large Cap Fund 22.8%
RSP Rydex S&P Equal Weight ETF 34.8%
EPS WisdomTree Earnings 500 Fund 19.8%
All returns as of 10/26/2009

Disclosure: Long IVV.