What Do Spiders Have To
Do With The Stock Market?
Everbody's chasing
performance nowadays, performance based on the Standard and Poors 500 Index,
that is. The reason is simple;
it has done very well. And one
of the ways that investors have gone along for the ride is by investing in
an"index" based mutual fund.
As you probably know, an index fund invests in all of the stocks that
make up a particular index. In
this case, it's the 500 stocks that comprise the S & P 500. It's clean and easy, and you're secure in knowing that you'll
consistently meet the benchmark that all portfolio managers are trying to
beat. That's great as long as
the market is going up. Now you
might be thinking,"Yeah, so what?
If the market is heading south, I can get out of my index fund on any
business day." This is
true, on any business day, but just at the end of the business day.
You see, mutual funds are priced once a day - after the close of the
business day. But, what if you
want out of your fund on a day the market is melting down?
You guessed it, you can get out at whatever the price is at the end
of the day.
Ouch!
Naturally, I wouldn't
be bringing this up if I didn't have a another option for you. And it’s in
the form of a spider, or more correctly SPDR, which is an acronym for the
Standard & Poor's Depositary Receipt.
It is the American Stock Exchange's (AMEX)
answer to the index fund, and is classified as a unit investment
trust (UIT)- which is a hybrid between a stock and a mutual fund.
To put it another way, it trades like any other stock but each share
represents a portfolio of 500 individual stocks.
The only time any change is made in the SPDR is when there is a
change made in the S&P 500 Index. The
shares are created when institutions, including the AMEX, deposit a stock
portfolio roughly equal in representation to the index, along with a cash
deposit equaling accumulated dividends.
These large blocks are called "creation units," and they
are the equivalent of an inititial public stock offering.
The shares are then traded on the open market at about one-tenth the
value of the S&P. So if the
S&P Index is trading at 1335, the SPDR will be trading at about 133 1/2.
The big advantage of
the SPDR is that, like any other stock, it can be bought and sold at any
time during market hours. Remember
that meltdown I mentioned before? Here's
your answer.
Another plus to SPDRs
is the way you're taxed. It's
the same way you're taxed on a stock transaction. When you sell, you either
incur a capital gain or a capital loss.
When you sell your mutual fund you either have a captal gain or a
capital loss, also. But you may
have to pay capital gains on your portion of stocks that the mutual fund
manager sold during the course of the year.
That's the ultimate insult; taking a loss on your mutual fund trade
and having to pay a capital gains tax.
Also, some mutual funds
do not let you trade in and out as often as you would like.
With a SPDR that's not an issue.
You can trade your brains out if you so desire.
I wouldn't recommend it though.
There are some
drawbacks to SPDRs, too. The
AMEX has a complicated system for reinvesting dividends.
Because SPDRs don't trade in partial shares, in order to participate
in the dividend reinvestment plan, the dividend payout would have to be
equal to the price of a share. For
example, if SPDRs are trading
at 135 a share, you have to wait for their dividends to accrue to $135
before reinvesting them in an additional share.
Another drawback is
that the AMEX doesn't offer a systematic investment plan. So, if you want to add money to your SPDR investment
every month, you have to pay a commission every time you make a purchase.
A third drawback is
that, because of the nature of the exchange, SPDRs can trade at a discount
to their net asset value. Let's
say the market is going down and the S&P 500 Index is trading at 1220.
Theoretically, the SPDR should be selling at 122.
But it may be selling at say, 121 1/2.
That's the market forces of supply and demand at work.
The reciprocal is true, also. If
the market is heading north, and the S&P is trading at 1300, the SPDR
may be trading ahead of the Index at say, 130 1/2.
Whatever the spread, it is usually temporary.
What I haven't
mentioned up to now is that SPDRs have a close cousin, Diamonds. Diamonds (DIAs) are the Dow Jones Industrial Average
equivalent. They also trade on
the AMEX but trade at one-hundreth the value of the "Dow."
So, if the Dow is trading at 11,100, the DIA will be trading at about
110. Many investors prefer DIAs
to SPDRs because the Dow is one of the most widely recognized indices in the
world.
As SPDRs and DIAs
become more popular, you can expect to see more investments based on the
same principals coming from Wall Street.
Dana Goldfarb is
a broker for Sutro & Company In Woodland Hills
Ca.
And Can Be Reached At (818) 313-8700
