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SPDRs and Diamonds

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Mutual funds are not the only way to invest in domestic indexes. Increasingly popular are so-called SPDRs or Standard & Poor's Depository Receipts, which track indexes just like a fund but trade like a stock on the American Stock Exchange.

 

Convenience and flexibility are their hallmark. Vis-à-vis mutual funds, SPDRs have some advantages. They can:

  • Trade at any brokerage firm
  • Be sold instantly in a falling market, not at the close of the day
  • Be margined at a brokerage firm
  • Result in slightly lower capital gains

Indexers with closet day trading tendencies or general nervousness about the market should find SPDRs appealing. It is possible to get in and out of these products many times each day. In a volatile market the knowledgeable or lucky investor could prosper, and an anxious investor can find comfort knowing it is easy to exit the market. But this is not typical of index investors, who tend to buy and hold.

Flavors

Various flavors of SPDRs (and the next-of-kin, Diamonds) include:

  • SPDRs (symbol: SPY), plain vanilla S&P 500
  • MidCap SPDRs (symbol: MDY), follows S&P MidCap 400
  • Select Sector SPDRs (9 funds, 9 symbols), which carve up the S&P 9 different ways
  • Diamonds (symbol: DIA), which tracks the Dow Jones Industrial Average

Like an index mutual fund, the above instruments track their indexes closely but not perfectly.

There is a little-known built-in profitability niche for arbitrage experts with lots of cash, but AMEX specifically refrains from this activity. [In a previous version of this article we mistakenly said AMEX also participated]. The arbitrageur can create and sell new SPDRs in blocks of 50,000 shares when they are selling at a premium and buy back and unwind them when they are selling at a discount. The profits from this arbitrage activity are unknown. On the other hand, this keeps the instrument stable.

Technically, SPDRs give the investor an ownership interest in a Trust established by AMEX where stocks purchased with the investor's money are held.

Are they low cost?

The plain vanilla and mid-cap versions and Diamonds are comparable to index funds, the sector SPDRs are a bit pricey for any large cap index. [In a previous version of this article I mistakenly criticized Diamonds for high expense ratios].

There are two costs to SPDRs: costs to buy and sell them (like any stock), and costs to operate them.

Purchasing a block of SPDRs can cost as little as $10 at an online discount brokerage, which amortized over time or over a large account is insignificant. But for a very small portfolio held only a short time, $10 in and $10 out will have some effect.

In addition, the following are estimated annual operating expenses based on recent history:

SPDR

.18%
MidCap SPDRs .25%
Select Sector SPDRs .65%

Diamonds

.18%

AMEX actually ran up much higher expenses in starting up Diamonds but did not pass them on to investors [correction from previous version of this article.]
                   

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