Evolution of the S&P 500 Composition

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k66
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Evolution of the S&P 500 Composition

Post by k66 » Tue Sep 20, 2016 11:00 pm

From the Reformed Broker:

Evolution of the S&P 500 Composition
To me, the most important line in the story is the final one, quoting S&P Dow Jones committee member David Blitzer: “At the end of the day, it’s more an art, not a science.”
Slightly thought provoking in that the 500 is not as rigid as I might otherwise assume that it is. If nothing else, it reinforces my choice in employing the Total Market fund rather than the 500.
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JoMoney
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Re: Evolution of the S&P 500 Composition

Post by JoMoney » Wed Sep 21, 2016 2:49 am

Every investable index, including 'Total Market' indices, have selection criteria rules and a committee that has to be the arbiter when the rules aren't always clear (which happens quite often when determining whether a stock should count as a U.S. market or International).
It is interesting to see how the S&P index has changed over time, and to a certain extent I agree with his statement in the post that "It’s a massive distraction for investors to obsess over how they’re doing versus a passive index that is, itself, created actively.".
But when someone is paying an active manager with the expectation of performance, then I think the obsession isn't at all out of line. An investor should very well know what it is they're paying for, and what sort of risks their money manager is taking.
Despite a multitude of changes over the years, the S&P index has always aimed at tracking the broad U.S. market, and it's done a very good job of it.
Given the changes in the composition of the market, and the industries in the economy as a whole, it's a wonder that some people expect that a 'tilt' to some sub-section of stocks today is anything like the types of companies that existed 50+ years ago.
I don't think there's even anything wrong with active management per se if it's done at low cost, low turnover, and with eye towards maintaining a conservative risk profile. The problems with active management comes from the fees and the potential risks being taken chasing higher returns. A broad market index fund is just a low cost way to get exposure to an 'average' amount of risk in the stock market, and that's all one should expect from an active manager as well.. it's when people (including fund managers) start chasing after higher returns that people get into trouble,
Benjamin Graham, in The Intelligent Investor wrote: ...Businessmen seek professional advice on various elements of their business, but they do not expect to be told how to make a profit. That is their own bailiwick. When they, or nonbusiness people, rely on others to make investment profits for them, they are expecting a kind of result for which there is no true counterpart in ordinary business affairs.
If we assume that there are normal or standard income results to be obtained from investing money in securities, then the role of the adviser can be more readily established. He will use his superior training and experience to protect his clients against mistakes and to make sure that they obtain the results to which their money is entitled. It is when the investor demands more than an average return on his money, or when his adviser undertakes to do better for him, that the question arises whether more is being asked or promised than is likely to be delivered.
Economics is not a science, and despite what the EMH pundits and factor mavens purport, there is more of an art or skill to investing with an aim to higher returns than searching for some obtuse measurement of "risk" and trying to load up on that.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Evolution of the S&P 500 Composition

Post by Valuethinker » Wed Sep 21, 2016 5:10 am

k66 wrote:From the Reformed Broker:

Evolution of the S&P 500 Composition
To me, the most important line in the story is the final one, quoting S&P Dow Jones committee member David Blitzer: “At the end of the day, it’s more an art, not a science.”
Slightly thought provoking in that the 500 is not as rigid as I might otherwise assume that it is. If nothing else, it reinforces my choice in employing the Total Market fund rather than the 500.
Yes.

And Malkiel makes that point in later editions of his books-- recommending TSM over S&P500. A hedge fund strategy of going long likely entrants, and short likely demotions, has been profitable (one of the Russell indices is purely mathematical in construction, and that strategy was particularly profitable).

Thus transferring performance from index funds to the hedge funds.

You want to minimize turnover (in a taxable space; also because dealing/ market impact costs are significant especially for small cap stocks) and holding everything listed, in proportion, is one way to do that-- you only have to buy/ sell to meet fund inflows/ outflows (you can use stock futures to reduce the market impact cost of that) and when a company is taken over or delisted.

One issue is whether VG TSM gets too big to be able to deal. The good news is that it probably doesn't have to hold many of the bottom 2000 or so listed stocks, to get market performance (because of their small size).

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nisiprius
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Re: Evolution of the S&P 500 Composition

Post by nisiprius » Wed Sep 21, 2016 7:13 am

What people say about the S&P 500 is interesting, in a pedantic sort of way, and I like that sort of stuff, in a trivia-contest sort of way. But always think about the possible motives for devoting such attention to relatively small details.

It's an attack on indexing itself, by attacking the best-known index. "The S&P 500 is actively managed" has almost become a meme. The followup, implied or explicit, is "...you say you aren't interested in what I'm selling because you're a passive investor, but you aren't, so go ahead, why not?" That O'Doul's you're drinking isn't really non-alcoholic, it's 0.5% alcohol, so go ahead, why not...

Here's my "attack" on the S&P 500. It's supposed to measure U.S. stocks; S&P itself says "The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities." Yet it includes international stocks! Yes, it does! Check it out: Mylan N.V., Schlumberger, Ltd., Garmin Ltd. How come they're not "Inc.?" Because they're foreign, that's how come! Look it up. So what? Who cares? It doesn't matter; it's trivia-contest stuff.

The big spin in Brown's article is that his block pictures and his characterization of the index as "created actively" and "an art, not a science" entirely concern arbitrariness in the sector classifications within the index itself. He complains about "rivals Wal-Mart and Target being in two different sectors (Staples and Discretionary, respectively)"--but it doesn't matter. It's a cap-weighted index. That's part of the virtue of a cap-weighted index. Walmart Stores is about 0.6% of the S&P 500 index by cap-weight. If it were reclassified tomorrow into Discretionary, it would still be 0.6% of the S&P 500 by cap-weight. Vanguard wouldn't need to buy or sell one share of stock to update to the "new" composition.

A fact like "REITs were spun out of the Financials and are now their own sector – at 3% of the whole" just doesn't matter to an S&P 500 index investor. It certainly affects someone who owns a financial sector fund or ETF that tracks the S&P Financial Select Sector Index, such as XLF. It certainly affects someone who is using an index that isn't cap-weighted--one in which, perhaps, the allocations have been adjusted to invest the same number of dollars in every sector. It doesn't affect an S&P 500 index investor. It doesn't affect a total market investor.

It is not a "massive distraction for investors to obsess over how they’re doing versus a passive index that is, itself, created actively" for an obvious reason: you can, in fact, easily invest in any of a number of very inexpensive funds that come within a few basis points of tracking the index. It's not at all irrelevant to compare your performance with that of a dead-easy, dead-cheap alternative.

The obvious question to ask is "Suppose the S&P 500 were truly passive. Suppose it just consisted of the largest companies by capitalization, instead of a committee choice of 'leading companies in leading industries?'" How much difference would it make? We can almost answer this and it's trivially easy. The Vanguard Large-Cap Index Fund tracks the "CRSP US Large Cap Index," which currently contains 611 stocks, and you can read the selection rules:
Image
No guff about "leading companies" or "leading industries" there.

The Russell 1000 is another well-known rules-based, transparent large-cap index.

So let's look at the difference between the Vanguard 500 index fund, VFIAX, tracking the "active" S&P 500 index (blue); a real fund with real money that tracks Russell 1000 index (iShares IWB, orange); and a real fund with real money that tracks the CRSP US Large-Cap Index (Vanguard's VLACX, blue).

So if you own an S&P 500 index fund, the next time Brown asks you about your investments you can say "I'm a passive investor in the CRSP Large-Cap Index." And if he says "Oh, you own the Vanguard Large-Cap Index fund?" you can reply "No, I own the Vanguard 500 Index Fund--it's close enough."

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Re: Evolution of the S&P 500 Composition

Post by Valuethinker » Wed Sep 21, 2016 7:36 am

nisiprius wrote:What people say about the S&P 500 is interesting, in a pedantic sort of way, and I like that sort of stuff, in a trivia-contest sort of way. But always think about the possible motives for devoting such attention to relatively small details.
Nisi

All great stuff. The main problem with certain index constructions is that they allow arbitrage against them. Therefore one really needs to look at the *funds* that track the indices, rather than indices themselves.

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Re: Evolution of the S&P 500 Composition

Post by rattlenap » Wed Sep 21, 2016 8:44 am

Say what they want about the S&P 500. For myself, the S&P 500 is my sole stock fund and the only one I invest into and the only thing I trust when it comes to stocks.

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Re: Evolution of the S&P 500 Composition

Post by nisiprius » Wed Sep 21, 2016 11:03 am

Valuethinker wrote:
nisiprius wrote:What people say about the S&P 500 is interesting, in a pedantic sort of way, and I like that sort of stuff, in a trivia-contest sort of way. But always think about the possible motives for devoting such attention to relatively small details.
Nisi

All great stuff. The main problem with certain index constructions is that they allow arbitrage against them. Therefore one really needs to look at the *funds* that track the indices, rather than indices themselves.
The key sentence in Brown's article is against benchmarking itself. The article makes two points.

1) We shouldn't benchmark, because...
2) the most familiar benchmark has flaws.
Brown wrote:It’s a massive distraction for investors to obsess over how they’re doing versus a passive index that is, itself, created actively.
No, it's not.

1) The S&P 500 index itself isn't active enough to matter. It's virtually identical to truly passive large-cap indexes.

2) "Obsessing" over anything isn't good, but benchmarking "how we're doing" is good. And benchmarking the offerings of active mutual funds and active strategies is not "a massive distraction." On the contrary, articles like his are a distraction from doing what we should be doing.

3) Yes, it would better if all the financial news started reporting a total market index in lieu of the S&P 500, but it's not likely to happen soon. If he's saying that we would be better off comparing how we're doing to the CRSP Large-Cap Index or the Russell 1000... or a total stock market index... I'd agree in theory, but I don't think that's what he's saying.

4) Yes, the S&P 500 index itself has flaws, but categorizing Walmart and Target into different sectors isn't one of them.

5) There have been various estimates of the effect of front-running on the S&P 500, but if it were huge, my chart ought to show an important underperformance in the Vanguard 500 index fund, relative to the funds that index to a harder-to-front-run indexes. I'll leave it to the mavens to say whether the tiny underperformance of VFIAX relative to the others actually is a visible result of front-running the S&P or to the funds having very slightly different style-box weightings.
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Re: Evolution of the S&P 500 Composition

Post by Copernicus » Sat Dec 16, 2017 5:23 pm

nisiprius wrote:
Wed Sep 21, 2016 7:13 am
Vanguard wouldn't need to buy or sell one share of stock to update to the "new" composition.
Here we go, the next changes to sectors:
https://www.barrons.com/articles/reinve ... 1509161295

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JoMoney
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Re: Evolution of the S&P 500 Composition

Post by JoMoney » Sun Dec 17, 2017 2:29 pm

Copernicus wrote:
Sat Dec 16, 2017 5:23 pm
nisiprius wrote:
Wed Sep 21, 2016 7:13 am
Vanguard wouldn't need to buy or sell one share of stock to update to the "new" composition.
Here we go, the next changes to sectors:
https://www.barrons.com/articles/reinve ... 1509161295
I hit a paywall at that link, here's one that doesn't seem to have one http://www.cetusnews.com/business/Reinv ... 2xf0Z.html
A misleading title on that article
"A proposed telecom index overhaul could affect everything from sector funds to ETFs that track the S&P 500."
... Reassigning companies to different sectors would affect the holdings of the sector-specific exchange-traded funds that track the index—and actively managed funds whose managers strive to hew closely to the S&P 500’s sector weightings ...
It's only "proposed", which doesn't mean much, and even then it doesn't appear to impact people who own a S&P 500 index fund or ETF as implied. Only people who buy sector funds.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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A Total Market Fund Advantage.

Post by Taylor Larimore » Sun Dec 17, 2017 3:16 pm

Bogleheads:

Investors who hold a market portfolio have little need to worry about the composition of individual stocks, categories or index construction.

For example, a fund manager or its benchmark index must sell a stock (creating transaction costs) when it moves from a small-cap category to a mid-cap category. In a total market fund the stock does not need to be sold or bought.

Best wishes.
Taylor
Last edited by Taylor Larimore on Sun Dec 17, 2017 5:05 pm, edited 1 time in total.
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Copernicus
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Re: Evolution of the S&P 500 Composition

Post by Copernicus » Sun Dec 17, 2017 4:22 pm

JoMoney wrote:
Sun Dec 17, 2017 2:29 pm

I hit a paywall at that link, here's one that doesn't seem to have one http://www.cetusnews.com/business/Reinv ... 2xf0Z.html
How do you find the version with no paywall?

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JoMoney
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Re: Evolution of the S&P 500 Composition

Post by JoMoney » Mon Dec 18, 2017 12:25 am

Copernicus wrote:
Sun Dec 17, 2017 4:22 pm
JoMoney wrote:
Sun Dec 17, 2017 2:29 pm

I hit a paywall at that link, here's one that doesn't seem to have one http://www.cetusnews.com/business/Reinv ... 2xf0Z.html
How do you find the version with no paywall?
I searched for the title: "Reinventing Telecom
A proposed index overhaul could affect everything from sector funds to ETFs that track the S&P 500"
And looked for an alternative. I use duckduckgo.com for search.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

Copernicus
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Re: Evolution of the S&P 500 Composition

Post by Copernicus » Tue Dec 19, 2017 5:41 pm

Thank you, JoMoney. I had never heard of that search engine, but will try it next time.

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