Old Guard ETFs Hemorrhaging

NEW YORK ( TheStreet) -- State Street's SPDR S&P 500 ETF ( SPY) -- the oldest, largest ETF in the U.S. -- is hemorrhaging cash in a trend that may continue no matter which way the market's headed.

The iconic SPY, which is designed to track the S&P 500 index, saw net outflows of more than $19.4 billion in 2009 and $16 billion in January 2010 alone.

According to State Street's Web site, the fund's total assets were $66.074 billion as of Feb. 4. SPY's assets as of Dec. 31, 2008, and Dec. 31, 2009, were $84.9 billion and $93.9 billion respectively.

Some of SPY's outflows can be traced to a broader retreat from U.S. equities. Other iconic broad-market ETFs also had recent asset outflows. The PowerShares QQQ ( QQQQ) and Diamonds Trust ( DIA) had net outflows of $1.2 billion and $705 million in January 2010, respectively.

To just compare SPY's losses to those of other older, entrenched, broad-market ETFs, however, is to miss the most important shift.

The ETF industry is evolving as it expands, and the customer is changing as well. ETF investors have learned to drive a hard bargain, and the "old guard" of ETF symbols is making way for the new.

As investors have become increasingly educated about ETFs, they have begun to notice three key distinguishing factors: fees, strategy and availability.

The greatest evidence of this change has been the relative strength, and even growth, of the iShares S&P 500 ( IVV), Vanguard MSCI Total Market ( VTI) and Schwab S Broad Market ( SCHB) ETFs over the past year.

IVV, which was launched more than seven years after SPY, is designed to capitalize on a structural difference between the two S&P 500 ETFs. SPY is structured as a unit investment trust, which legally prohibits the fund from reinvesting dividends, loaning securities to institutions for extra income, or purchasing futures and options to more closely track the index. IVV, an open-ended index fund, has extra flexibility.

SPY has a low expense ratio of 0.10%, but iShares set IVV's still lower at 0.09%. Even though SPY still trumps IVV when it comes to trading volume, both funds are certainly large and liquid enough for the purposes of most investors.

As more than $19 billion exited SPY in 2009, IVV had a net cash flow of $1.95 billion.

Vanguard's MSCI Total Market ETF and Schwab's US Broad Market ETF also pose a long-term challenge to SPY. While both SPY and IVV track just large and midcap stocks, VTI and SCHB include small-caps in their portfolios.

Launched in 2001 and November 2009 respectively, VTI and SCHB have expense ratios of 0.09% and 0.08% respectively. VTI had a net cash flows of $1.6 billion in 2009 and $116 million in January 2010. Even though SCHB traded for just two months in 2009, the ETF had $89 in net assets as of Dec. 31, 2009, and had a net asset inflow of $44 million in January 2010.

Perhaps the most significant challenge SPY will face in the months ahead is the availability of IVV and SCHB to a new group of no-commission investors.

Schwab ( SCHW) may be new to the ETF industry, but the launch of the firm's new line of proprietary ETFs was shrewdly aimed at the firm's established asset management clients. When Schwab launched its first four ETFs in November 2009, it announced that the funds would be available commission-free to brokerage customers.

Schwab's move was a landmark moment for both the ETF industry and its customers. No-commission trading helps to promote stickier customer bases and allows those investors to dollar-cost-average. Funds like SCHB should continue to grow as Schwab customers shift assets from funds like SPY to in-house commission-free ETFs.

iShares' IVV also stands to benefit from a recent partnership with Fidelity Investments. According to a recent announcement, Fidelity customers will be able to trade IVV along with 24 other iShares products commission free through their online brokerage accounts.

Both Schwab's and Fidelity's commission-free ETF deals could sponge volume from veteran SPY. More importantly, as both firms establish their presence in the ETF industry, a new long-term oriented investor pool will enter the market for ETFs.

While the ETF industry is still relatively young, it's ready for a shake-up. First-mover funds like SPY and large-institutional investors have dominated the ETF universe in the past. Firms like Fidelity and every-day investors will shape the future.

-- Written by Don Dion in Williamstown, Mass.
At the time of publication, Dion owns PowerSharesQQQ, DIAMONDS Trust.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.

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