Can someone explain how UK based S&P ETF trackers track!

[AndrewInDevon]

I need some basic education!

I own an S&P500 ETF tracker (CSP1, an iShares product). This is listed on the LSE. My question is quite basic and probably very silly but I am lost to explain it....what is the ETF tracking when the US market is closed and the UK market open?

When I compare long-term graphs of the ETF to the index it is clearly tracking the index very closely, but when I look at daily movements on the 'Stocks' app on my iPhone its fluctuating all the time but US markets are fast asleep.

[londoninvestor]

S&P index futures trade pretty much 24 hours a day. The equivalent level of the S&P index can be inferred straightforwardly from the futures price and from interest rates, so you'd expect the ETF to closely track that.

[mc2fool]

While the managers of an ETF will try to make the net asset value (NAV) of the ETF track the index they're following, the price of ETFs in the market is determined by supply and demand and may vary from the NAV.

In other words, the price of ETFs in the market doesn't track an index, it tracks investors' opinion of the index, although for major ETFs tracking major indices you can expect the two to be pretty darn close most of the time.

In the sort of case you're referring to, of international ETFs with markets being open at different times, once the US market is closed the NAV of the S&P ETF will be "frozen" until it reopens, but the price while the London market is open will continue to vary according to investors' expectations (educated guesses) as to what the NAV will be when the US market does reopen. As already noted, that will be informed by S&P index futures.

[JohnW]

I don't think it is tracking anything. It stopped tracking after close of business (in USA), and will re-start tracking when the US markets open again.
If you look at a long term graph you might not see daily variations since they're small compared to the scale of the graph. Your ETF value can fluctuate when the USA is asleep because investors in Bristol who are awake might think that a missile just fired from somewhere is going to have an impact on prices in USA when it opens next. Is that what it's about?
A quite interesting interview with a fund manager here, revealing some of what they do to track an index. Hint: it's a quite a lot. https://boglecenter.net/2023conference/

[londoninvestor]

While the managers of an ETF will try to make the net asset value (NAV) of the ETF track the index they're following, the price of ETFs in the market is determined by supply and demand and may vary from the NAV.

As well as supply and demand in terms of cash purchases of ETF shares, there's also the mechanism where Authorised Participants can deliver up ETF shares and receive the basket of underlyings, or vice versa. That's another factor puling the ETF price close to the underlying.

[londoninvestor]

I don't think it is tracking anything. It stopped tracking after close of business (in USA), and will re-start tracking when the US markets open again.

When the cash market is closed but the futures market is open (which for the S&P is pretty much 24 hours a day), you'd be unlikely to see the ETF deviate far from the underlying, because there are straightforward arbitrages that automated trading systems can do.

[Lootman]

While the managers of an ETF will try to make the net asset value (NAV) of the ETF track the index they're following, the price of ETFs in the market is determined by supply and demand and may vary from the NAV.

As well as supply and demand in terms of cash purchases of ETF shares, there's also the mechanism where Authorised Participants can deliver up ETF shares and receive the basket of underlyings, or vice versa. That's another factor puling the ETF price close to the underlying.

Yes, ETFs successfully track their underlying indices by virtue of arbitrage. If there is a deviation from the index then a profit can be made by buying the ETF units and selling the underlying basket of stocks, or vice versa.

This works remarkably well as you can see from the low tracking error and tight spreads of major market ETFs.

The less liquid the underlying market, the tougher it is to arbitrage it, and so potentially the greater the tracking error and premium/discount. In the case of the underlying market failing or freezing, then any ability to arbitrage will also fail. But in that situation open-ended funds will probably be halted and closed-ended funds will go to huge discounts, so you are screwed every which way. I have only seen this happen in fringe markets.

[1nvest]

You may find your fund tracks the S&P500TN index, S&P500 total return net of 30% US dividend withholding taxes. If paying a 4% dividend then 2.8% net. 1.2% to the US treasury. Likely the fund will be domiciled in Ireland that has a similar treaty with the US as the UK's US treaty, that reduces the withholding tax by half. 0.6% tax instead. The fund might deduct 0.1% in fund management fees, so you end up with 0.7% less. Funds may hold the actual shares in the index in the proportionate weights and use futures to make fine adjustment so that it ends up looking like its tracked the S&P500TN index, less its 0.1% fees. But hang on, that's the one that's 1.3% below the actual gross total return index. Oh well! The financial sector does have to fund its high wages and expensive buildings somehow. Of course when it comes to sales literature they'll present gross figures. Market makers also take their cut, bid/ask spreads, as does the broker in fees. Years ago when dividend yields of 4%+ were common, market makers often widened their spreads out to 10%+, as did brokers charge £100/trade in back-then money.

[Lootman]

You may find your fund tracks the S&P500TN index, S&P500 total return net of 30% US dividend withholding taxes. If paying a 4% dividend then 2.8% net. 1.2% to the US treasury. Likely the fund will be domiciled in Ireland that has a similar treaty with the US as the UK's US treaty, that reduces the withholding tax by half. 0.6% tax instead. The fund might deduct 0.1% in fund management fees, so you end up with 0.7% less. Funds may hold the actual shares in the index in the proportionate weights and use futures to make fine adjustment so that it ends up looking like its tracked the S&P500TN index, less its 0.1% fees. But hang on, that's the one that's 1.3% below the actual gross total return index. Oh well! The financial sector does have to fund its high wages and expensive buildings somehow. Of course when it comes to sales literature they'll present gross figures. Market makers also take their cut, bid/ask spreads, as does the broker in fees. Years ago when dividend yields of 4%+ were common, market makers often widened their spreads out to 10%+, as did brokers charge £100/trade in back-then money.

You are exaggerating there.

Irish-domiciled ETFs have a 15% withholding rate for the dividends on US shares. Given that dividend yields are low in the US this is not a large factor. So for example the Vanguard S&P 500 ETF ticker VUSA is currently showing an annual yield of 1.14%. 15% of that is about 0.17% a year.

The annual charge is just 0.07% a year.

Taking those together your holding cost is about 24 basis points a year. Can you show me a cheaper way of tracking the S&P 500? (US based investors can track it for free but I assume that you cannot invest that way).

[UkFIREcheese]

just buy voo and dont look!

[1nvest]

So for example the Vanguard S&P 500 ETF ticker VUSA is currently showing an annual yield of 1.14%. 15% of that is about 0.17% a year.

The annual charge is just 0.07% a year.

Historic lows, in reflection of low interest rates etc. Longer term historic average dividends were more like 4.4% average gross, 2.9% net of basic rate taxation (where typically tax rates have increased during times of economic stress - higher interest rates/dividend yields/inflation).

VUSA factsheet https://fund-docs.vanguard.com/SandP_50 ... _UK_EN.pdf indicates 1.4% dividend yield, but also indicates

The S&P 500 Net Total Return Index represents price-plus-net cash dividend return. Net cash dividend equals reinvested dividends less 30% withholding tax.

So the gross dividend was 2%.

In the mid 1980's US stocks did move over to retaining more of earnings in reflection of increased US dividend taxation policies. More recently the rules have been changed to raise barriers against stocks repurchasing their own shares.

[AndrewInDevon]

All informative and educational thanks. The replies made me realise I don't really know how ETFs work, but then on reflection I've never understood how electricity or the internet works, but I am confident I know how to use them.

Andrew

[kempiejon]

just buy voo and dont look!

VOO isn't easily available to most UK investors. VOO is Vanguard's S&P ETF for US retail investors.
VUSA is the puppy for UK retail investors.

[hiriskpaul]

You may find your fund tracks the S&P500TN index, S&P500 total return net of 30% US dividend withholding taxes. If paying a 4% dividend then 2.8% net. 1.2% to the US treasury. Likely the fund will be domiciled in Ireland that has a similar treaty with the US as the UK's US treaty, that reduces the withholding tax by half. 0.6% tax instead. The fund might deduct 0.1% in fund management fees, so you end up with 0.7% less. Funds may hold the actual shares in the index in the proportionate weights and use futures to make fine adjustment so that it ends up looking like its tracked the S&P500TN index, less its 0.1% fees. But hang on, that's the one that's 1.3% below the actual gross total return index. Oh well! The financial sector does have to fund its high wages and expensive buildings somehow. Of course when it comes to sales literature they'll present gross figures. Market makers also take their cut, bid/ask spreads, as does the broker in fees. Years ago when dividend yields of 4%+ were common, market makers often widened their spreads out to 10%+, as did brokers charge £100/trade in back-then money.

You are exaggerating there.

Irish-domiciled ETFs have a 15% withholding rate for the dividends on US shares. Given that dividend yields are low in the US this is not a large factor. So for example the Vanguard S&P 500 ETF ticker VUSA is currently showing an annual yield of 1.14%. 15% of that is about 0.17% a year.

The annual charge is just 0.07% a year.

Taking those together your holding cost is about 24 basis points a year. Can you show me a cheaper way of tracking the S&P 500? (US based investors can track it for free but I assume that you cannot invest that way).

There is a way to reduce the WHT cost, but it introduces some credit risk. An ETF provider can invest in a portfolio of stocks paying zero to low dividends, then enter into a swap agreement with a bank. The agreement would be such that the bank pays the ETF the total return on the S&P 500 and the ETF pays the bank the return on the stocks portfolio, plus a fee. As the stocks portfolio pays next to nothing in dividends next to no WHT is paid.

iShares I500 is such an example and has beaten the conventional iShares S&P 500 ETF CSP1 by the amount you would expect it to since launch. There are other examples, eg Invesco have been running something similar for longer than iShares and has also beaten conventional ETFs.

[hiriskpaul]

just buy voo and dont look!

VOO isn't easily available to most UK investors. VOO is Vanguard's S&P ETF for US retail investors.
VUSA is the puppy for UK retail investors.

If you shop around you might find a broker that let's you buy VOO. You just have to satisfy them that you are a professional investor. I am not altogether clear what the criteria is now, but I have this status at IG and they allow me to buy US listed Vanguard ETFs. Anyone doing this should be careful to check that any ETF they buy has UK reporting status as many do not. Most, if not all, of the Vanguard ETFs do have UK reporting status.

[1nvest]

There is a way to reduce the WHT cost, but it introduces some credit risk. An ETF provider can invest in a portfolio of stocks paying zero to low dividends, then enter into a swap agreement with a bank. The agreement would be such that the bank pays the ETF the total return on the S&P 500 and the ETF pays the bank the return on the stocks portfolio, plus a fee. As the stocks portfolio pays next to nothing in dividends next to no WHT is paid.

iShares I500 is such an example and has beaten the conventional iShares S&P 500 ETF CSP1 by the amount you would expect it to since launch. There are other examples, eg Invesco have been running something similar for longer than iShares and has also beaten conventional ETFs.

THANKS (shame you can up-vote only once)

Another alternative is that UK (FTSE250) and US midcap have yielded similar risk/rewards (volatility/gains). Much of recent great S&P500 gains are down to 7 or so individual stocks. At other times that works the other way around and the S&P500 relatively lags (dot com bubble bursting for instance). Similar for the FTSE100, which has relatively lagged since the 2000's due to being overweighted into stocks/sectors that have lagged (but that could turn around if those overweighted stocks/sectors did relatively well). Midcap is more neutral, is more towards equal weighted, is somewhat value'ish (stocks that fall out of the larger index into the midcap will more often pull out all the stops to try and get back into the main index again, small stocks that fall out of the bottom end of the midcap are replaced with 'better' up/rising stocks). And no one stock tends to rise to being 10% or suchlike weighted - rather such stocks are promoted into the main/large index well before they might become over-dominant of the midcap index.

Without that over-concentration element the likes of HYP1 and TJH's HYP have been similar to the FTSE250 total returns. i.e. tilting towards particular individual sectors/stocks can be a win, can be a lose. Overall the more equal weighted (tilt towards smaller cap) can be > main index

US data https://www.portfoliovisualizer.com/bac ... 1z8TmXUjNX

Portfolio CAGR Stdev Sharpe Ratio
US Stock Market 10.66% 15.74% 0.44
US Mid Cap 11.80% 17.47% 0.47



... and where there's no US WHT, so those gross figures are likely better in net terms.

FTSE250 perhaps mixed in with US non dividend stocks, and gold instead of bonds https://www.portfoliovisualizer.com/bac ... vGc8pD5696

[1nvest]

There is a way to reduce the WHT cost, but it introduces some credit risk. An ETF provider can invest in a portfolio of stocks paying zero to low dividends, then enter into a swap agreement with a bank. The agreement would be such that the bank pays the ETF the total return on the S&P 500 and the ETF pays the bank the return on the stocks portfolio, plus a fee. As the stocks portfolio pays next to nothing in dividends next to no WHT is paid.

iShares I500 is such an example and has beaten the conventional iShares S&P 500 ETF CSP1 by the amount you would expect it to since launch. There are other examples, eg Invesco have been running something similar for longer than iShares and has also beaten conventional ETFs.

Looking at Invesco's longer 10 year history and I'm seeing that as having lagged the S&P500 gross total return by 0.2%/year. Another full replication index that benchmarked to the regular total return index and lagged that by 0.1% fund management fees lagged the gross total return by 0.65%. So a 0.45% year difference. And that's over a period of low dividend yields (low inflation/interest rates), over other periods that could increase to being 1% or more. Of course A N other index funds tend to just highlight their 0.1% lag relative to the benchmark, so look relatively good, but in practice someone with a £1M portfolio value is foregoing £4500/year compared to had they been invested via Invesco or Blackrock (iShares). That's perhaps enough to pay your Council Tax, Water rates and Energy bills for the year.

For concentration risk reduction holding both Invesco and iShares funds and perhaps also VMIG (VMID outside of ISA, FTSE250 tracker that has tended to broadly align/compare to US midcap).

[1nvest]

VOO isn't easily available to most UK investors. VOO is Vanguard's S&P ETF for US retail investors.
VUSA is the puppy for UK retail investors.

If you shop around you might find a broker that let's you buy VOO. You just have to satisfy them that you are a professional investor. I am not altogether clear what the criteria is now, but I have this status at IG and they allow me to buy US listed Vanguard ETFs. Anyone doing this should be careful to check that any ETF they buy has UK reporting status as many do not. Most, if not all, of the Vanguard ETFs do have UK reporting status.

As a pro I suspect you already know ... but if Mr Bad Busdriver gets you tomorrow then any US assets that in total are over $60,000 IIRC will require that your heirs have to file for US Estate Tax. There are generous allowances where Brits can benefit from the same allowances as Yanks, something like $12M of exemption, but the correct forms have to be submitted correctly filled in within the correct timescale ... or otherwise be at risk of the same (punitive) US Estate Tax as other countries that have no tax treaty with the US.

Holding a fund domiciled in Ireland and if Mr Bad Busdriver gets you then its the fund that owns the US assets, there's no US Estate Tax factors/issues involved.

[hiriskpaul]

If you shop around you might find a broker that let's you buy VOO. You just have to satisfy them that you are a professional investor. I am not altogether clear what the criteria is now, but I have this status at IG and they allow me to buy US listed Vanguard ETFs. Anyone doing this should be careful to check that any ETF they buy has UK reporting status as many do not. Most, if not all, of the Vanguard ETFs do have UK reporting status.

As a pro I suspect you already know ... but if Mr Bad Busdriver gets you tomorrow then any US assets that in total are over $60,000 IIRC will require that your heirs have to file for US Estate Tax. There are generous allowances where Brits can benefit from the same allowances as Yanks, something like $12M of exemption, but the correct forms have to be submitted correctly filled in within the correct timescale ... or otherwise be at risk of the same (punitive) US Estate Tax as other countries that have no tax treaty with the US.

Holding a fund domiciled in Ireland and if Mr Bad Busdriver gets you then its the fund that owns the US assets, there's no US Estate Tax factors/issues involved.

Yes, I have left a note with my Will alerting my executors to this requirement. Ideally I would hold I500 instead of US listed ETFs, but my US listed ETFs pre-date I500 and I need to unwind the positions to mitigate CGT. I do at least get a tax credit for the WHT on US dividends, but it would be better to not pay it in the first place.

[hiriskpaul]

There is a way to reduce the WHT cost, but it introduces some credit risk. An ETF provider can invest in a portfolio of stocks paying zero to low dividends, then enter into a swap agreement with a bank. The agreement would be such that the bank pays the ETF the total return on the S&P 500 and the ETF pays the bank the return on the stocks portfolio, plus a fee. As the stocks portfolio pays next to nothing in dividends next to no WHT is paid.

iShares I500 is such an example and has beaten the conventional iShares S&P 500 ETF CSP1 by the amount you would expect it to since launch. There are other examples, eg Invesco have been running something similar for longer than iShares and has also beaten conventional ETFs.

Looking at Invesco's longer 10 year history and I'm seeing that as having lagged the S&P500 gross total return by 0.2%/year. Another full replication index that benchmarked to the regular total return index and lagged that by 0.1% fund management fees lagged the gross total return by 0.65%. So a 0.45% year difference. And that's over a period of low dividend yields (low inflation/interest rates), over other periods that could increase to being 1% or more. Of course A N other index funds tend to just highlight their 0.1% lag relative to the benchmark, so look relatively good, but in practice someone with a £1M portfolio value is foregoing £4500/year compared to had they been invested via Invesco or Blackrock (iShares). That's perhaps enough to pay your Council Tax, Water rates and Energy bills for the year.

For concentration risk reduction holding both Invesco and iShares funds and perhaps also VMIG (VMID outside of ISA, FTSE250 tracker that has tended to broadly align/compare to US midcap).

Invesco reduced the management fee on their swap based ETF a few years ago, which explains why their 10 year return spread is wider than the 5 year.