Meet One of ETF’s Founding Fathers

Episode Summary

Executive Summary: The episode centers on Jay Baker’s firsthand account of SPY’s creation and early struggle at the American Stock Exchange, explaining how an exchange seeking volume helped invent the modern ETF industry. Baker recounts the legal, structural, and marketing decisions that turned SPY from a slow-starting product into the world’s largest ETF, while reflecting on ETF evolution, tax-efficient conversions, and future growth areas.

Main Topics: Origins of SPY and the ETF industry (Priority: 5/5): Jay Baker describes how SPY emerged from Amex’s effort to create a tradable product after market turmoil and regulatory pressure, and how Nate Most and Steve Bloom engineered the concept around physically backed securities. Early legal and structural challenges (Priority: 5/5): The discussion covers the earlier IPS product, the Chicago Mercantile lawsuit, and why SPY was structured as a unit investment trust to avoid board costs and preserve simplicity, despite trading limitations like no stock lending. Marketing and institutional adoption (Priority: 5/5): Baker explains the Amex-led push to market SPY to Wall Street firms, the key turning point at Daiwa Securities, and how early creation/redemption activity drove the product’s credibility and liquidity. SPY’s growth into a dominant market infrastructure product (Priority: 5/5): The hosts and Baker emphasize that SPY became far more than a product: it created an industry, became the most-traded ETF, and helped shape ETF market mechanics and investor behavior. ETF evolution beyond plain-vanilla indexing (Priority: 4/5): The conversation shifts to modern ETF innovation, including fixed income ETFs, single-stock ETFs, thematic products, and the limits of what the ETF wrapper can successfully support. Tax efficiency and conversions as future growth (Priority: 4/5): Baker argues that mutual fund-to-ETF conversions and separately managed account conversions are a major future growth channel because ETFs can preserve tax efficiency and lower costs. The role of personalities in innovation (Priority: 4/5): The episode highlights the contrasting but complementary roles of Nate Most and Steve Bloom—older, experienced, forceful, and execution-oriented—whose persistence made SPY possible.

Key Arguments: SPY succeeded because it was physically backed by stocks, not a futures contract, and was sold as a true security with lower cost and high transparency. The Amex needed a volume-generating innovation because it struggled to attract top listings; SPY became the exchange’s homegrown solution. A key adoption catalyst came when Daiwa Securities created large SPY positions to lend out to short sellers, which helped establish recurring trading and visibility. SPY’s growth was driven by the market seeing large prints and realizing that assets were actually flowing into the fund, not just shares trading hands. ETF innovation still has room to grow, especially in fixed income and tax-free conversions from mutual funds and SMAs. Single-stock ETFs have not yet proven broadly successful, suggesting investors still prefer simpler, diversified structures. Marketing matters in ETFs because, unlike the mutual fund world’s old distribution/kickback model, ETF issuers must earn attention in a merit-based marketplace.

Data Points: SPY current assets: $372 billion - Host cites SPY’s size as the largest ETF in the world. SPY day-one trading volume: 1 million shares - Baker says early trading was boosted by a promotional hat giveaway. Large early prints: Two prints of 500,000 shares - These were reportedly done to obtain a SPY hat. Low-volume period: 17,500 shares in one day - Baker says this occurred in spring 1993 before institutional adoption accelerated. Marketing target: $200 million - Amex senior executive Ivers Riley tasked Baker and Steve Bloom with reaching this asset level by year-end. SPY launch date: January 29, 1993 - Baker states SPY launched in late January 1993. Initial creations on day one: Three creation units - Each creation unit was 50,000 shares. Initial assets on day one: About $6.7 million - Based on 150,000 shares created at roughly $45 per share. Launch price: $45 - SPY launched when the S&P 500 was around 450, using a divisor of 10. Fee level: 9.5 basis points - Baker and the hosts discuss SPY’s expense ratio versus lower-cost competitors. Competing fund fees: 3 basis points - Hosts compare SPY with Vanguard and BlackRock S&P 500 products. Daiwa creation tranche: About $200 million - Baker says Daiwa created large blocks to support shorting and lending activity. 1994 trading volume: 100 million shares for the year - Baker says this equated to about 400,000 shares per day. Amex market share near end: Less than 1% - Baker notes the exchange traded a tiny share of total SPY volume despite creating the product. ETF flow in a year: $607 billion - Baker references industry inflows in the prior year. ETF flow in prior year: $750 billion - Baker cites a higher inflow figure from the year before. JETS assets at pandemic low: $40 million - Baker says the airline ETF was dormant before COVID-era volatility. JETS peak assets: $6 billion - Baker and the hosts note the ETF surged during the pandemic. Single-stock ETF assets: About $100 million for the Tesla product - Baker says most single-stock ETFs have not gathered significant assets. ETC firm assets: $5.5 billion - Baker says his firm currently manages this amount. SPY trust structure lifespan: 20 years per generation of trust beneficiaries - Hosts and Baker discuss the legal workaround using children in the trust documents.

Pivotal Quotes: "They started out making a product, but ended up creating an industry." — Eric Balchunas: Used to frame SPY’s historical significance and the ETF market’s birth. "I love the spider. I own the spider. And you are never, ever, ever going to get in our office again. And by the way, I hope you fail." — Jay Baker: Baker recounts a hostile call that convinced him SPY would succeed because it threatened incumbents. "The marketplace sorts out these products too." — Jay Baker: Baker explains that successful ETFs must prove value and attract assets through demand, not just idea quality.

Implications: SPY’s story shows that ETF success depends on structure, trust, low cost, and relentless distribution. The future likely belongs to tax-efficient conversions and practical fixed-income innovations, while flashy wrapper experiments may remain niche.