S tate Street Global Advisors, the largest provider of U.S. sector exchange-traded funds with $93.9 billion in assets across 11 ETFs as of the end of May, plans to pay out a sizable special dividend to its shareholders in mid-September. Following implementation of an upcoming index change, investors in the company's highly popular Financial Select Sector SPDR (XLF) will receive shares in the much smaller and less liquid Real Estate Select Sector SPDR (XLRE).
Dating back to 1998, State Street has been a leading provider of sector strategies tied to the S&P 500. XLF is the biggest of these offerings, with $16.85 billion in assets, though the ETF has shed $2.21 billion of assets through net withdrawals year-to-date through June 7.
In October 2015, to round out its lineup and to reflect the pending GICS changes, State Street launched two new sector ETFs. However, investor demand for XLRE and Financial Services Select Sector SPDR (XLFS) has been limited. The $13.6 million XLFS holds the financials stocks in the S&P 500, excluding those REITs that would be part of the new sector.
S&P Dow Jones Indices announced June 7 that the Financial Select Sector Index will drop all real estate companies after the close of business Sept. 16 when real estate is elevated to the 11th GICS sector. Following these changes, XLF in mid-September will exclude all REITs, with the exception of mortgage REITs, in an attempt to efficiently track its underlying index.
As of June 7, the REIT industry made up 18.5% of assets of XLF and was the second largest behind banks, at 34.28%, and ahead of insurance at 16.78%.
Meanwhile, the $12.7 million XLRE held an 11.1% stake in Simon Property Group Inc., an 8.2% stake in American Tower Corp., a 6.8% stake in Public Storage and a 5.6% stake in Crown Castle International Corp. as of June 7. Both XLRE and XLFS trade fewer than 5,000 shares on a daily basis.
In contrast, XLF trades more than 38 million shares and is popular with institutional investors because of its strong liquidity and its exposure to S&P 500 constituents. As of June 7, XLF held a 9.0% weighting in Berkshire Hathaway Inc., an 8.1% weighting in JPMorgan Chase & Co., a 7.9% weighting in Wells Fargo & Co. and a 5.0% weighting in Bank of America Corp.
Rather than sell out its exposure to American Tower, Simon Property, Public Storage and 25 other REIT companies that would no longer be a part of the index it tracks, State Street will pay a special dividend to XLF shareholders, in the form of XLRE. The dividend record date is Sept. 21, and the dividend will be paid Sept. 22. Based on current assets and weightings, this would be equal to $3.12 billion of new assets in XLRE.
We are engaged with our clients and the board of Sector SPDRs to make sure we can support a change in the marketplace being driven by indexes.
In a conversation with S&P Global Market Intelligence in May, prior to the latest S&P Dow Jones index developments, State Street Global Advisors Executive Vice President Jim Ross said the company was engaged with its clients and the board of Sector SPDRs "to make sure we can support a change in the marketplace being driven by indexes."
The company recently said it plans to waive XLRE's expense ratio, at 14 basis points, until Sept. 16. In comparison, Schwab US REIT ETF (SCHH) and Vanguard REIT Index ETF (VNQ) cost 7 basis points and 12 basis points, respectively. With $31.17 billion in assets, VNQ is the largest REIT ETF.
The sizable new client base in XLRE will provide this ETF with greater liquidity and enable all of its shareholders to transact in a lower-cost way. However, it is likely that some XLF shareholders will not want to maintain an equal weighting in REITs through an ETF, which should create some enhanced trading activity in large-cap REITs.
After Sept. 22, when State Street plans to pay out the special dividend, the weightings in large-cap banks and insurance companies will move higher. If demand for XLF returns, remaining constituents, such as Berkshire and JPMorgan Chase, would benefit as new ETF shares are created.