The SPDR S&P 500 ETF Trust (NYSEARCA:SPY) and other traditional exchange-traded funds usually are not as exciting as many other ETFs. But SPY stock and its rivals are becoming less boring.
First, a quick lesson on what the SPDR S&P 500 ETF and its primary rivals – the iShares Core S&P 500 ETF (NYSEARCA:IVV) and the Vanguard S&P 500 ETF (NYSEARCA:VOO) – are designed to do. These funds, as their names imply, track the S&P 500.
Because the S&P 500 is a widely followed, highly liquid, large-cap benchmark, the tracking error of these ETFs is minimal, meaning investors should expect returns in-line with the index’s performance, minus each fund’s fee.
For example, if the S&P 500 jumps 20% in a year, the return on SPY stock will be 19.9055% due to the ETF’s annual fee of 0.0945%, or $9.45, on a $10,000 investment.
The components of SPDR S&P 500 and the other S&P 500 ETFs I’ve mentioned are weighted by market capitalization. That means the largest company by market capitalization constitutes the highest percentage of the benchmark, the second-largest firm by market capitalization constitutes the highest percentage of the benchmark, and so on. As a result, Apple (NASDAQ:AAPL) is SPDR S&P 500’s biggest holding.
SPY Stock, Say Hello to Tesla
Recently, SPDR S&P 500 and the other ETFs that track the index have been in the news a great deal, perhaps more so than usual, because Tesla (NASDAQ:TSLA) was finally added to the S&P 500 on Dec. 18 and began impacting the index on Dec. 21.
The introduction of the electric-vehicle maker to the benchmark was arguably the most anticipated change in the index in a generation. Elon Musk’s company was also the largest-ever addition to the benchmark.
When it was added to the S&P 500, Tesla sported a market capitalization north of $600 billion. As a result, the EV maker became the sixth-largest holding of the SPDR S&P 500 and the other ETFs, That was one of the highest debut positions on record, though the shares subsequently slid back to number seven before the market opened on Dec. 22. At that time, Tesla constituted 1.58% of the ETFs’ holdings.
With TSLA stock up almost 700% in 2020, the addition of this name to SPDR S&P 500 brings an element of glamour to the ETFs, but for long-term investors, the hoopla surrounding Tesla’s inclusion in the gauge will fade.
“What we’ve seen over time is that because these events are so widely publicized, because these stocks and these benchmarks are so widely followed, that index-inclusion effect is really diminished over time,” says Morningstar ETF Research Directors Ben Johnson. “And when you frame it in the long-term performance of whatever the benchmark in question might be, it really doesn’t have all that big of an effect.”
The SPDR S&P 500 ETF Is Becoming Less Diverse
While Tesla’s inclusion in the S&P 500 is commanding plenty of headlines, investors should realize that the index and ETFs that track it are becoming less diverse. I’ve previously highlighted that issue.
Typically investors own broad market funds like SPDR S&P 500 because they want, well, broad exposure. Home to 505 stocks apiece, the S&P 500 ETFs are broad by that metric. However. due to the seemingly never-ending gains by stocks such as Apple, Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN), these ETFs’ price action is increasingly largely determined by a small number of names.
After the market closed on Dec. 21, Apple, Microsoft and Amazon collectively accounted for 16.37% of the S&P 500 ETF’s holdings. And the technology sector represented 27.6% of the ETF’s assets, more than double the weight of the healthcare space, the sector to which it has the second-highest exposure.
Apple constitutes 6.58% of the ETF. Putting that into context, the combined weight of the 30 smallest members of the S&P 500 is barely equal to that of the iPhone maker.
That’s what happens when the index is weighted by market capitalization. After all, the benchmark is supposed to represent the market’s collective wisdom, and that wisdom clearly favors Apple, Microsoft, Amazon and a handful of other names.
On the date of publication, Todd Shriber owned shares of VOO.
Todd Shriber has been an InvestorPlace contributor since 2014.
