The Story of the First US ETF

The First US ETF Story

  • The SPDR® S&P 500® ETF (SPY), a basket of securities that tracks the performance of the S&P 500® Index, launched in 1993 as the first US-listed ETF.
  • Thirty years later, SPY is the largest,1 liquid,2 and the world’s most heavily traded ETF,3 with an average trading volume of 39 billion dollars per day.4
  • SPY democratized investing – opening the door to markets that were inaccessible to most investors prior to 1993.

“Bedlam on Wall Street,” screams the front page of the Los Angeles Times.

The New York Times reports that “Stocks Drop 508 Points…World Impact.”

The front page of The Wall Street Journal clearly stated: “The stock market crashed yesterday.”

Think about it. October 19, 1987 – known as “Black Monday”. Global markets fell so suddenly that it is believed that the damage caused to the stock market was more significant than the Great Depression. Almost immediately, the installers began trying to figure out what had gone wrong.

In the process, investigators at the Securities and Exchange Commission (SEC) noticed something. The stock market had no single security to represent the broader market, with futures contracts on the S&P 500® Index. Believing that such a vehicle might mitigate the damage—or even avoid the crisis altogether—the SEC expressed interest in developing an entirely new type of security.5

Born of the Crisis, SPY Changed Investing Forever

Fast forward to January 1993. A group of financial executives ring the opening bell at the American Stock Exchange (AMEX), officially launching the first US-listed exchange traded fund (ETF). The word SPY flashes on the screen for the first time. It is the result of a three-year partnership between State Street and AMEX, which was later acquired by the New York Stock Exchange (NYSE) in 2008.

Finally, a basket of securities tracking the performance of the S&P 500® Index had made its debut. But someone was missing in the ring party. Jim Ross, jokingly referred to by his colleagues as “The Plumber,” returned to his Boston office, tasked behind the scenes to lead a successful SPY day.

In the weeks leading up to the launch, Jim and his State Street colleagues experienced their fair share of sleepless nights making sure SPY’s inner workings were running smoothly. They ran countless tests to transfer 500 securities from one broker-dealer to State Street, while transferring shares that could then be traded on the stock market by the same broker-dealer. It had never been done before – and no one was 100 percent sure it could happen.

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AMEX was initially close to State Street, the leading indexing and closing/clearing giant for its portfolio management expertise and proven cash movement capabilities. But ETFs present some unique challenges.

While ETFs trade on an exchange like stocks and bonds, the underlying fund must have actual owners. “If it was a $100 million fund,” Jim shares, “it had to have $100 million in assets that were primarily indexed.”

Complicating matters, since both funds and securities must flow and be settled in real time, a day’s worth of checks was required.

“Since we were seeded not only with cash, but with S&P 500® securities, we had to check 500 individual securities,” Jim explains. “Normally, this process takes 45 days. But for the ETF to work, it had to be completed within 16 hours – between the market closing at 4pm and the market opening the next morning (9:30am). To prepare the funds and complete the audit, significant planning was required.”

In the end, SPY came out successful. “It caught on with institutional trading communities, large investors, and even buy-and-hold investors,” says Jim. “They saw SPY as a way to buy the S&P 500® in a safe, cost-effective way.”

One of SPY’s first significant investors was overseas – an Australian pension fund. “Back then,” Jim says, “buying a mutual fund required you to fill out an application. It was a very different process. But with SPY, you can buy on the exchange. So, all of a sudden, you have retirement funds that foreign buys and holds to move retirees halfway around the world to US equity markets.

Use ETFs Like SPY to Solve New Challenges

Thirty years later, there are more than 8,000 ETFs6 which track specific industries, sectors, commodities and geographies. But still, SPY remains the biggest7 and the world’s most traded ETF.8

In fact, SPY trades 3.12 times more than Apple (AAPL) – the world’s largest security by market capitalization.9 That volume, along with the size of SPY’s assets, its flexibility, and its resilience in different market conditions, is essential for building portfolios for some of the world’s most sophisticated traders and in helping investors during times of market turmoil.

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One of SPY’s first stress tests came after the September 11 attacks, when US stock markets were closed for six days. It was the first trade disruption to last longer than four consecutive days in 50 years.10 After markets reopened on September 17, investors largely sold industries such as retail airlines. But market participants used the SPY price as an implied value for the S&P 500® components, providing transparency and time for the market to adjust and correct.

Since 9/11, ETFs have added an additional but essential source of liquidity to the market during several market shutdowns, composite trading halts, market disruptions, natural disasters, and human error—providing investors with a means to survive the crisis. exit the market. in real time.

In fact, since the market began its sharp declines at the onset of COVID-19, SPY became the first ETF to trade more than $100 billion in a single day on February 28, 2020.11 These elevated volumes in times of stress reinforce that SPY is a mainstay of the financial world, and show that investors are drawn to its deep pool of liquidity – especially when it’s needed most.

Inspiring Innovation Among Investors

When it comes to the innovation that SPY inspired, Jim Ross compares ETFs to the iPhone. “The iPhone platform was an important discovery, of course, but the real revolution is all the innovative ways that people use the power of the smartphone in their daily lives. Similarly, not all innovation in the ETF space comes from providers. A lot of it comes from investors. are directed.”

It identifies insurance companies that use ETFs for their public accounts, in addition to bonds, as investment vehicles. And also to financial advisors who use ETFs for allocation and diversification planning. A number of wealth management firms use ETFs to package their investment beliefs into net products for their clients. ETFs have also been used to create model portfolios that give advisors the ability to extract the investment portion so they can focus on client outcomes.

Today, despite their explosive growth, ETFs still represent less than 9% of the total investment market.12 But with the inherent advantages, due to insider trading and transparency on pricing, ETF adoption is on the rise. By 2022, 65% of advisors plan to use ETFs in their portfolios, and 41% of advisors are looking to increase their use of ETFs in the next twelve months.13

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From Revolution to Progress

SPY paved the way for a more democratic approach to investing – opening the door to markets that were inaccessible to most investors prior to 1993.

Now, 30 years later, the ways investors use ETFs have evolved. ETFs have become essential building blocks when making asset allocation decisions, and they have allowed financial advisors to focus on investor outcomes with greater efficiency – through targeted investment to match portfolio objectives and better transparency of underlying holdings, which enables appropriate maintenance.

How are investors currently using SPY and other ETFs?

In any market, and especially in times of volatility, liquidity is important. SPY and other ETFs trade daily on the exchange, and have multiple layers of liquidity due to the creation and redemption process. The power of ETFs is to help investors get in and out of the markets quickly, easily and at a reasonable cost.

ETFs typically track an index, so investors can invest in a basket of securities in one trade. Like mutual funds, SPY and other ETFs can help investors build diversified portfolios efficiently and cost-effectively.

Risk Management
The wide range of ETFs available today makes risk management approaches possible for individuals and smaller institutions that were previously only accessible to large institutional investors.

Securities Lending
Investors can use SPY to potentially generate an additional source of income through securities lending, or the process of lending shares to other investors. Lending of assets is a fundamental aspect of capital markets activity that facilitates settlement, provides liquidity, and strengthens the confidence to take risk.

Flexibility in Implementation
Because of SPY’s trading volume and high liquidity, the depth of SPY’s secondary market allows for a range of execution strategies and offers implicit transaction cost benefits within those execution strategies.

Any way you look at it, the SPY revolution that sparked was a success for investors. “When this all started, we thought ETFs would be used mostly by trading houses or maybe some hedge funds,” Jim says. “Boy, were we wrong?”

Source: State Street


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