50 Biggest Companies Dominate the S&P 500

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Random Walker
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50 Biggest Companies Dominate the S&P 500

Post by Random Walker » Tue Dec 22, 2009 11:36 am

Read an interesting statistic in Bogle's new book. We all pretty much know that the S&P 500 comprises about 75% of the total stock market. But I was surprised to learn that the 50 biggest companies in the S&P 500 comprise about 35% of the total stock market! Does that have any implications for how divesified we view an S&P 500 fund to be?

Dave

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Re: 50 Biggest Companies Dominate the S&P 500

Post by YDNAL » Tue Dec 22, 2009 11:57 am

Random Walker wrote:Read an interesting statistic in Bogle's new book. We all pretty much know that the S&P 500 comprises about 75% of the total stock market. But I was surprised to learn that the 50 biggest companies in the S&P 500 comprise about 35% of the total stock market! Does that have any implications for how divesified we view an S&P 500 fund to be?

Dave
.Dave,

There have been recent threads discussing this issue -- I've taken the side of *equal weight* S&P500 during discussions. :twisted:
Equal-Weighted S&P 500 Superior to Market-Cap Weighted (RSP vs. SPY)
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Post by Opponent Process » Tue Dec 22, 2009 12:09 pm

on a similar note, the US is about 30% of global market cap, pretty impressive compared to Qatar (0.2%).

I wouldn't recommend holding equal amounts of money in these two.
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Re: 50 Biggest Companies Dominate the S&P 500

Post by YDNAL » Tue Dec 22, 2009 12:39 pm

Opponent Process wrote:on a similar note, the US is about 30% of global market cap, pretty impressive compared to Qatar (0.2%).

I wouldn't recommend holding equal amounts of money in these two.
Informed investors normally (often? sometimes?) make realistic comparisons in evaluating data and strategies. The market caps within the S&P500 vary from a bit over 3% to 0.1% - in contrast to Countries/Regions with vastly distinct economic, political and social structures and polar-different global market weights.
Index Component Weights of Stocks in the S&P 500
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Re: 50 Biggest Companies Dominate the S&P 500

Post by Beagler » Tue Dec 22, 2009 12:44 pm

Random Walker wrote:Read an interesting statistic in Bogle's new book. We all pretty much know that the S&P 500 comprises about 75% of the total stock market. But I was surprised to learn that the 50 biggest companies in the S&P 500 comprise about 35% of the total stock market! Does that have any implications for how divesified we view an S&P 500 fund to be?

Dave
Cap-weighting in action.

It's no wonder Dr. Bernstein recommends S&D in his new book.
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Re: 50 Biggest Companies Dominate the S&P 500

Post by G-Money » Tue Dec 22, 2009 1:23 pm

Random Walker wrote:Read an interesting statistic in Bogle's new book. We all pretty much know that the S&P 500 comprises about 75% of the total stock market. But I was surprised to learn that the 50 biggest companies in the S&P 500 comprise about 35% of the total stock market! Does that have any implications for how divesified we view an S&P 500 fund to be?

Dave
This is not a unique phenomenon. http://en.wikipedia.org/wiki/Pareto_principle

I personally don't worry or care that the biggest companies in any cap-weighted index "dominate" the index. I view it this way: Imagine there are only 3 companies in the world, A, B, and C, all with a market cap of X. A cap-weighted index would hold A, B, and C evenly (so would an equal-weight index, obviously).

Now, imagine A acquires C. Now there are only 2 companies: A and B. A's market cap is 2X, and B's market cap is X. Company A has a bigger market cap because it has more assets, more operations, etc.; it's Company A and C together. A cap-weighted index will hold twice as much A than B, but essentially has the same exact composition as before (when it held A, B, and C). If you equal-weight, you must underweight A and overweight B relative to their market value.

There's a reason why deviating away from market cap is called "tilting" or "overweighting." To me, these concepts seem to be at odds with "diversification." Others will disagree, often with the aid of fancy charts and number-crunching.

My $0.02.

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Re: 50 Biggest Companies Dominate the S&P 500

Post by G-Money » Tue Dec 22, 2009 1:29 pm

YDNAL wrote:
Opponent Process wrote:on a similar note, the US is about 30% of global market cap, pretty impressive compared to Qatar (0.2%).

I wouldn't recommend holding equal amounts of money in these two.
Informed investors normally (often? sometimes?) make realistic comparisons in evaluating data and strategies. The market caps within the S&P500 vary from a bit over 3% to 0.1% - in contrast to Countries/Regions with vastly distinct economic, political and social structures and polar-different global market weights.
Index Component Weights of Stocks in the S&P 500
According to the chart in your link, the smallest company in the S&P 500 is 0.01% of the index, not 0.1%. Thus, the largest company (Exxon) is 328 times the size of the smallest company (Titanium Metals) in the index (3.28% vs. 0.01%).

In contrast, assuming Opponent Process's numbers are accurate, the U.S. is only 150 times the size of Qatar (30% vs. 0.2%), a ratio less than half that between Exxon and Titanium Metals.

Just saying. :wink:

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Re: 50 Biggest Companies Dominate the S&P 500

Post by Beagler » Tue Dec 22, 2009 1:31 pm

G-Money wrote:
I personally don't worry or care that the biggest companies in any cap-weighted index "dominate" the index.
http://tinyurl.com/y85db7t
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Post by Random Walker » Tue Dec 22, 2009 1:33 pm

Opponent Process
If you lived in Qatar, what would your portfolio look like? :D . Would you display home country bias, confusing familiar with safe?

G-Money
but if you're invested in three companies, your spreading your risks across three managements. With two companies, only two managements. Makes sense to me that no matter how you divide the pie, you are still investing in the same amount of business. But more distinct companies seems like more diversified bets.

Dave

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Re: 50 Biggest Companies Dominate the S&P 500

Post by G-Money » Tue Dec 22, 2009 1:41 pm

Beagler wrote:
G-Money wrote:
I personally don't worry or care that the biggest companies in any cap-weighted index "dominate" the index.
http://tinyurl.com/y85db7t
Overweighting smaller companies and underweighting larger ones simply puts you at greater "bubble risk" for the smaller companies and less "bubble risk" for the larger ones. Pick your poison.

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Post by Opponent Process » Tue Dec 22, 2009 1:41 pm

Random Walker wrote:Opponent Process
If you lived in Qatar, what would your portfolio look like? :D . Would you display home country bias, confusing familiar with safe?
0.2% Qatar. the beauty of total market investing is that the theoretical optimal portfolio is the same no matter where you live.

but I'd have more wives as a diversifier.
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Post by G-Money » Tue Dec 22, 2009 1:45 pm

Random Walker wrote:G-Money
but if you're invested in three companies, your spreading your risks across three managements. With two companies, only two managements. Makes sense to me that no matter how you divide the pie, you are still investing in the same amount of business. But more distinct companies seems like more diversified bets.

Dave
If management risk is the only risk you're worried about, then by all means, equal-weight. I believe it is generally accepted that market risk entails much, much more than management risk.

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Post by Wagnerjb » Tue Dec 22, 2009 1:48 pm

Random Walker wrote:but if you're invested in three companies, your spreading your risks across three managements. With two companies, only two managements. Makes sense to me that no matter how you divide the pie, you are still investing in the same amount of business. But more distinct companies seems like more diversified bets.

Dave
I disagree. First of all, if you invested in more companies to "spread your management risk" across more companies, you shouldn't be investing in equities. If you honestly feel that management is a "risk" rather than an assets, you aren't suitable to own an interest in a company.

Second, investing in Exxon is much more diversified than investing in 5 companies that are 2% of the size of Exxon. If Exxon drills a large expensive well and it comes up dry (no oil or natural gas), nothing happens. Exxon continues to thrive. But such a "dry hole" may cripple a tiny company. If your company owns one refinery and it blows up....your company goes to zero. But nothing happens to Exxon.

Exxon is naturally diversified - due to its size - from the kinds of risks that could cripple a small company. Investing in market weights will solve this problem. Say one refinery blows up. By owning TSM, you are sure it will only result in a 0.001% loss. Either Exxon declines by 0.03% or your tiny one-factory company goes to zero....but was only 0.001% of the value of TSM anyway.

Best wishes.
Andy

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Opponent Process

Post by Random Walker » Tue Dec 22, 2009 1:51 pm

With regard to AA you and I think alike. If a portfolio works in one place, I think it should work elsewhere as well.
Now with regard to more wives increasing diversification. In general I like the concept of adding different risky assets to decrease the overall volatility of a portfolio. But sometimes adding a riskier asset to a portfolio just makes the portfolio riskier. Adding extra wives MUST increase the volatility of the wife portfolio as a whole! Don't care what the correlation coefficients are in this case. To evaluate this portfolio you would not use standard deviation, you would need some sort of drama index.

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Post by Beagler » Tue Dec 22, 2009 2:04 pm

Thankfully, those who've invested in [cap-weighed] TSM have been richly rewarded by its performance over the past decade. :D
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Re: 50 Biggest Companies Dominate the S&P 500

Post by YDNAL » Tue Dec 22, 2009 2:04 pm

G-Money wrote:
YDNAL wrote:
Opponent Process wrote:on a similar note, the US is about 30% of global market cap, pretty impressive compared to Qatar (0.2%).

I wouldn't recommend holding equal amounts of money in these two.
Informed investors normally (often? sometimes?) make realistic comparisons in evaluating data and strategies. The market caps within the S&P500 vary from a bit over 3% to 0.1% - in contrast to Countries/Regions with vastly distinct economic, political and social structures and polar-different global market weights.
Index Component Weights of Stocks in the S&P 500
According to the chart in your link, the smallest company in the S&P 500 is 0.01% of the index, not 0.1%. Thus, the largest company (Exxon) is 328 times the size of the smallest company (Titanium Metals) in the index (3.28% vs. 0.01%).

In contrast, assuming Opponent Process's numbers are accurate, the U.S. is only 150 times the size of Qatar (30% vs. 0.2%), a ratio less than half that between Exxon and Titanium Metals.

Just saying. :wink:
G-Money,

We are looking at extremes.. so lets dial-back some to Top 10 for easier presentation and to visualize.

1) With a $19.30 investment in S&P500, are you better diversified with:

Rank.. Company.. Weight
1 ExxonMobil 3.28
2 Microsoft 2.38
3 Procter & Gamble 1.81
4 Apple 1.80
5 Johnson & Johnson 1.79
6 IBM 1.71
7 General Electric 1.67
8 JPMorgan Chase 1.66
9 AT&T 1.64
10 Chevron 1.57

or....

Rank.. Company.. Weight
1 ExxonMobil 1.93
2 Microsoft 1.93
3 Procter & Gamble 1.93
4 Apple 1.93
5 Johnson & Johnson 1.93
6 IBM 1.93
7 General Electric 1.93
8 JPMorgan Chase 1.93
9 AT&T 1.93
10 Chevron 1.93

2) How about projected returns to effect the overall return of the 2 Indices?
3) What happened during dot com days to the Index?
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Re: 50 Biggest Companies Dominate the S&P 500

Post by G-Money » Tue Dec 22, 2009 2:40 pm

YDNAL wrote:
G-Money wrote:
YDNAL wrote:
Opponent Process wrote:on a similar note, the US is about 30% of global market cap, pretty impressive compared to Qatar (0.2%).

I wouldn't recommend holding equal amounts of money in these two.
Informed investors normally (often? sometimes?) make realistic comparisons in evaluating data and strategies. The market caps within the S&P500 vary from a bit over 3% to 0.1% - in contrast to Countries/Regions with vastly distinct economic, political and social structures and polar-different global market weights.
Index Component Weights of Stocks in the S&P 500
According to the chart in your link, the smallest company in the S&P 500 is 0.01% of the index, not 0.1%. Thus, the largest company (Exxon) is 328 times the size of the smallest company (Titanium Metals) in the index (3.28% vs. 0.01%).

In contrast, assuming Opponent Process's numbers are accurate, the U.S. is only 150 times the size of Qatar (30% vs. 0.2%), a ratio less than half that between Exxon and Titanium Metals.

Just saying. :wink:
G-Money,

We are looking at extremes.. so lets dial-back some to Top 10 for easier presentation and to visualize.

1) With a $19.30 investment in S&P500, are you better diversified with:

Rank.. Company.. Weight
1 ExxonMobil 3.28
2 Microsoft 2.38
3 Procter & Gamble 1.81
4 Apple 1.80
5 Johnson & Johnson 1.79
6 IBM 1.71
7 General Electric 1.67
8 JPMorgan Chase 1.66
9 AT&T 1.64
10 Chevron 1.57

or....

Rank.. Company.. Weight
1 ExxonMobil 1.93
2 Microsoft 1.93
3 Procter & Gamble 1.93
4 Apple 1.93
5 Johnson & Johnson 1.93
6 IBM 1.93
7 General Electric 1.93
8 JPMorgan Chase 1.93
9 AT&T 1.93
10 Chevron 1.93

2) How about projected returns to effect the overall return of the 2 Indices?
3) What happened during dot com days to the Index?
Well, first of all, the cap-weight version gives me $19.31, rather than $19.30, so taking it will juice my returns an additional 0.05% right off the bat. :)

To answer your questions:
1) I'd still say 1 is more diversified, for the reasons I set forth above.
2) I have no idea what the projected returns would be for either portfolio. I thought we were talking about diversification.
3) I don't know what happened to either portfolio during the "dot com days," and I'm not sure looking at a few years is terribly meaningful for this type of analysis.

Exxon and Chevron are both in the oil business. For whatever reason, the market thinks Exxon is worth twice as much as Chevron. What do you know that the market doesn't?
Last edited by G-Money on Tue Dec 22, 2009 2:44 pm, edited 1 time in total.

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Re: 50 Biggest Companies Dominate the S&P 500

Post by Wagnerjb » Tue Dec 22, 2009 2:42 pm

Beagler wrote:
Random Walker wrote:Read an interesting statistic in Bogle's new book. We all pretty much know that the S&P 500 comprises about 75% of the total stock market. But I was surprised to learn that the 50 biggest companies in the S&P 500 comprise about 35% of the total stock market! Does that have any implications for how divesified we view an S&P 500 fund to be?

Dave
Cap-weighting in action.

It's no wonder Dr. Bernstein recommends S&D in his new book.
S&D doesn't improve diversification, it impairs diversification. But because S&D tends to overweight riskier asset classes like value and small cap, it results in higher long-term returns.

If S&D didn't result in higher returns, do you think anybody would recommend anything other than market weighting?

Best wishes.
Andy

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S&D and Diversification

Post by Random Walker » Tue Dec 22, 2009 2:52 pm

I think that an argument can be made for S&D improving diversification over a whole market approach. A whole market approach makes the portfolio dominated by one risk factor, beta. By slice and dice you gain more exposure to HML and SMB. These risk factors show significant lack of correlation to beta and to each other. So the S&D portfolio could be considered better diversified because of the portfolio's more broad exposure to the less than perfectly correlated risk factors that matter.

Dave

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Re: 50 Biggest Companies Dominate the S&P 500

Post by YDNAL » Tue Dec 22, 2009 3:12 pm

G-Money wrote:To answer your questions:
1) I'd still say 1 is more diversified, for the reasons I set forth above.
2) I have no idea what the projected returns would be for either portfolio. I thought we were talking about diversification.
3) I don't know what happened to either portfolio during the "dot com days," and I'm not sure looking at a few years is terribly meaningful for this type of analysis.

Exxon and Chevron are both in the oil business. For whatever reason, the market thinks Exxon is worth twice as much as Chevron. What do you know that the market doesn't?
IBM is 1.70 not 1.71 so you have no advantage! :)

1. What reasons? YDNAL's definition of Diversification is to invest where your dollars and cents are not concentrated in any specific Region, Country, Sector, Company, etc. (big ETC.)

2. Look at BtM and compute.

3. S&P 500's Best & Worst Stocks Since 2000
The first two tables list the best and worst performing current S&P 500 stocks since the bear market began on March 24, 2000 (it ended on October 9, 2002). XTO Energy (XTO) leads the top 25 list with a whopping return of over 2,188%, while JDS Uniphase Corp. (JDSU) has fallen over 98%. The list of winners is led by health care names while the list of losers is pretty much all tech and telecom.
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Re: 50 Biggest Companies Dominate the S&P 500

Post by G-Money » Tue Dec 22, 2009 3:31 pm

YDNAL wrote:
G-Money wrote:To answer your questions:
1) I'd still say 1 is more diversified, for the reasons I set forth above.
2) I have no idea what the projected returns would be for either portfolio. I thought we were talking about diversification.
3) I don't know what happened to either portfolio during the "dot com days," and I'm not sure looking at a few years is terribly meaningful for this type of analysis.

Exxon and Chevron are both in the oil business. For whatever reason, the market thinks Exxon is worth twice as much as Chevron. What do you know that the market doesn't?
IBM is 1.70 not 1.71 so you have no advantage! :)

1. What reasons? YDNAL's definition of Diversification is to invest where your dollars and cents are not concentrated in any specific Region, Country, Sector, Company, etc. (big ETC.)

2. Look at BtM and compute.

3. S&P 500's Best & Worst Stocks Since 2000
The first two tables list the best and worst performing current S&P 500 stocks since the bear market began on March 24, 2000 (it ended on October 9, 2002). XTO Energy (XTO) leads the top 25 list with a whopping return of over 2,188%, while JDS Uniphase Corp. (JDSU) has fallen over 98%. The list of winners is led by health care names while the list of losers is pretty much all tech and telecom.
1. Company Y has a market cap of $1,000,000. Company Z has a market cap of $100. You have $100 dollars to invest. Cap-weight would mean putting $99.99 in Y and $0.01 in Z, because the market has determined that Y is worth 10,000 times more Z. Equal-weight would put $50 in each. With cap-weight you'd own 0.01% of Y and Z. With equal-weight, you'd own 0.005% of Y and 50% of Z. Equal-weight looks like a fairly concentrated bet in Z to me.

2. I still have no idea how projected returns are relevant to the discussion of diversification.

3. Wouldn't you always expect there to be tremendous winners and losers? I don't know anything the market doesn't know (in fact, I know much, MUCH less). Why would I want to make bets (on smaller companies, for example) that differ from the market's? If I cap-weight, I've got the same odds as the market of picking the winners and avoiding the losers. Good enough for me.

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Re: 50 Biggest Companies Dominate the S&P 500

Post by YDNAL » Tue Dec 22, 2009 4:15 pm

G-Money wrote:
YDNAL wrote:
G-Money wrote:To answer your questions:
1) I'd still say 1 is more diversified, for the reasons I set forth above.
2) I have no idea what the projected returns would be for either portfolio. I thought we were talking about diversification.
3) I don't know what happened to either portfolio during the "dot com days," and I'm not sure looking at a few years is terribly meaningful for this type of analysis.

Exxon and Chevron are both in the oil business. For whatever reason, the market thinks Exxon is worth twice as much as Chevron. What do you know that the market doesn't?
IBM is 1.70 not 1.71 so you have no advantage! :)

1. What reasons? YDNAL's definition of Diversification is to invest where your dollars and cents are not concentrated in any specific Region, Country, Sector, Company, etc. (big ETC.)

2. Look at BtM and compute.

3. S&P 500's Best & Worst Stocks Since 2000
The first two tables list the best and worst performing current S&P 500 stocks since the bear market began on March 24, 2000 (it ended on October 9, 2002). XTO Energy (XTO) leads the top 25 list with a whopping return of over 2,188%, while JDS Uniphase Corp. (JDSU) has fallen over 98%. The list of winners is led by health care names while the list of losers is pretty much all tech and telecom.
1. Company Y has a market cap of $1,000,000. Company Z has a market cap of $100. You have $100 dollars to invest. Cap-weight would mean putting $99.99 in Y and $0.01 in Z, because the market has determined that Y is worth 10,000 times more Z. Equal-weight would put $50 in each. With cap-weight you'd own 0.01% of Y and Z. With equal-weight, you'd own 0.005% of Y and 50% of Z. Equal-weight looks like a fairly concentrated bet in Z to me.

2. I still have no idea how projected returns are relevant to the discussion of diversification.

3. Wouldn't you always expect there to be tremendous winners and losers? I don't know anything the market doesn't know (in fact, I know much, MUCH less). Why would I want to make bets (on smaller companies, for example) that differ from the market's? If I cap-weight, I've got the same odds as the market of picking the winners and avoiding the losers. Good enough for me.
One last time... you tend to be attracted to extremes. The example assumes a typical investor makes investments that can represent 50% of the market value of some company... that's not sensible within constrains of most indices. Since you just choose to ignore the Top 10, if you wish, take 127 Mega Caps.

In addition to diversification, projected returns are critical in evaluating investment strategies to help meet your plan(s)/goal(s).

You keep ignoring the effect of bubbles.

With regards to small companies, do you believe in REITs?... SC Value? Then, by default, you must believe in the Equity risk premia in riskier Small/Mid Caps.
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Post by ruud » Tue Dec 22, 2009 4:36 pm

there is one issue that nags me when i think about equal weighting: how do investors (or funds) who do equal weight "draw the line" at the number of companies to invest in?

for example, if you'd have $10,000 to invest, do you invest $1000 each in the biggest 10 companies, or $500 in the biggest 20, or $100 in the biggest 100 or $10 in 1000, etc.? how would you decide on the number of companies to invest in, what criteria would you use?

if you do cap weight (or even according to other metrics such as earnings), selecting more companies will have a progressively smaller effect, thus making the choice of number of companies a less important one.
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Re: 50 Biggest Companies Dominate the S&P 500

Post by ftobin » Tue Dec 22, 2009 4:48 pm

YDNAL wrote: With regards to small companies, do you believe in REITs?... SC Value? Then, by default, you must believe in the Equity risk premia in riskier Small/Mid Caps.
I find it interesting that there is an assumption that the reason SC and Value stocks outperform is because they are riskier and a require discount to price. I've felt another significant factor could be that larger institutional investors (the Gorillas in the market) might be overweighting larger companies as there is more liquidity, causing their prices to trade at a premium, and don't take the time to invest in the smallest companies, causing their prices to trade at a discount relative to larger caps. It's similar to the notion how Buffett says he will only look at companies above a certain market cap before he considers investing in them because it's not worth his time otherwise.

In other words, it may be that it's not the riskiness of small companies that gives the greater reward, but more the fact that big money flows more to large caps.

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Re: 50 Biggest Companies Dominate the S&P 500

Post by G-Money » Tue Dec 22, 2009 4:51 pm

YDANL wrote:One last time... you tend to be attracted to extremes. The example assumes a typical investor makes investments that can represent 50% of the market value of some company... that's not sensible within constrains of most indices. Since you just choose to ignore the Top 10, if you wish, take 127 Mega Caps.

In addition to diversification, projected returns are critical in evaluating investment strategies to help meet your plan(s)/goal(s).

You keep ignoring the effect of bubbles.

With regards to small companies, do you believe in REITs?... SC Value? Then, by default, you must believe in the Equity risk premia in riskier Small/Mid Caps.
1. RSP equal weights 500 companies. This means your bet on #500 is 2000% its market weight (0.2% vs. 0.01%). Your bet on #1 is 0.06% of its market weight. Why do you like #500 so much more than #1? The market doesn't. I trust you don't think my use of RSP is extreme, since you cited it.

2. Of course projected returns are critical. But they are generally meaningless in the context of our discussion of diversification. Plus, good luck getting a concensus on projected returns.

3. With equal-weight, you are at a much greater risk of bubbles in smaller companies than in larger ones. With cap-weight, you face equal risk that any particular company is in a bubble.

4. No, I don't invest separately in REITs or SC Value. I do have a US "bias," but that's because I'm still grappling with how to deal with or ignore currency risk, which is not compensated. That's a discussion for another thread (or 20).[/quote]

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Re: 50 Biggest Companies Dominate the S&P 500

Post by Rodc » Tue Dec 22, 2009 4:59 pm

ftobin wrote:
YDNAL wrote: With regards to small companies, do you believe in REITs?... SC Value? Then, by default, you must believe in the Equity risk premia in riskier Small/Mid Caps.
I find it interesting that there is an assumption that the reason SC and Value stocks outperform is because they are riskier and a require discount to price. I've felt another significant factor could be that larger institutional investors (the Gorillas in the market) might be overweighting larger companies as there is more liquidity, causing their prices to trade at a premium, and don't take the time to invest in the smallest companies, causing their prices to trade at a discount relative to larger caps. It's similar to the notion how Buffett says he will only look at companies above a certain market cap before he considers investing in them because it's not worth his time otherwise.

In other words, it may be that it's not the riskiness of small companies that gives the greater reward, but more the fact that big money flows more to large caps.
I have had similar thoughts. But I think the argument is more about small than about value. In fact you invoke Buffet, he may only invest in large because he has too much money to investing in small (he would need too many of them to soak up all the cash he has), but as far as I can tell, he does not mind buying cheap large companies. ;)

The game would then be that as a company grows large enough to start to attract "serious players" the price goes up. I have heard that argument made, but not sure how much is behind it.
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Post by ruud » Tue Dec 22, 2009 5:08 pm

an equal-weighted version of VTSMX (total stock market) would have to invest $34M ($116B / 3381) in every company listed on the stock market. that's more than the entire market cap of the some of the stocks it invests in. e.g., PTN has a market cap of just $26M.

interestingly VTSMX holds just $2 worth of PTN (6 shares).

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Post by peter71 » Tue Dec 22, 2009 5:15 pm

I continue to think the simplest way to understand the case for equal-weighting is that you're maximally spreading your "eggs" (dollars) across "baskets" (investments), and if XOM alone was 75% of the US market I'd care incredibly much about not putting 75% of my eggs in it . . . in pratice, however, cap-weighters are spreading 75% of their money across 50 baskets, and so I think people on both sides of the issue can agree that, semantics aside, there's not really all THAT much to fight about here . . .

All best,
Pete

EDIT -- make that 35% of one's eggs, which certainly reinforces the point! Not to get into semantics, but not sure I'd use term "dominate" for a 35% share. :D

Thoug on third thought I guess that's around 50% of the S&P.

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Post by Trev H » Tue Dec 22, 2009 5:38 pm

01/01/1970-12/21/2009

TSM
9.63 = cagr
18.41 = stdev

Large Cap Blend
9.72 = cagr
18.08 = stdev

.9920 = correlation

I expect that if I had the annual returns for a index composed of the 50 largest companies it would be very VERY similar.

I think (best I remember a recent post by Robert T) something like 80% of the stocks (by weight) in TSM fall in Decile 1 & 2 (the top 20%) of the market.

I know for a fact that the tiny bit of mid/small caps held in a cap weighted fashon do not affect the market in any form that could = diversification.

TSM is simply an illusion of diversification.

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Re: 50 Biggest Companies Dominate the S&P 500

Post by YDNAL » Tue Dec 22, 2009 5:43 pm

ftobin wrote:
YDNAL wrote: With regards to small companies, do you believe in REITs?... SC Value? Then, by default, you must believe in the Equity risk premia in riskier Small/Mid Caps.
I find it interesting that there is an assumption that the reason SC and Value stocks outperform is because they are riskier and a require discount to price..

In other words, it may be that it's not the riskiness of small companies that gives the greater reward, but more the fact that big money flows more to large caps.
ft,

I'm not sure why you group SC and Value.... I didn't.

The Fama/French 3-factor model explicitly shows SMB (Small Minus Big), to measure the additional return investors have historically received by investing in stocks of companies with relatively small market capitalization -- size premium.

It also shows HML (High Minus Low) to measure the Value premium by investing in companies with high BtM (book-to-market) values.
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Post by Trev H » Tue Dec 22, 2009 5:43 pm

Code: Select all

Size-Deciles: 

              As at Sept 30, 2005.              
           ---------------------------        
           Cumulative  
              No. of       % of Mkt Cap        
 Decile     Companies      
1               169            60.9                    
2               351            13.9                  
3               546             7.4                  
4               752             4.5                  
5               959             3.1                  
6              1197             2.7                  
7              1496             2.2                  
8              1848             2.0                  
9              2541             1.9                  
10             4287             1.5                  

Source: Ibboston Yearbook 

I found the data that Robert T posted (included above).

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Re: 50 Biggest Companies Dominate the S&P 500

Post by YDNAL » Tue Dec 22, 2009 6:01 pm

G-Money wrote:1. RSP equal weights 500 companies. This means your bet on #500 is 2000% its market weight (0.2% vs. 0.01%). Your bet on #1 is 0.06% of its market weight. Why do you like #500 so much more than #1? The market doesn't. I trust you don't think my use of RSP is extreme, since you cited it.

2. Of course projected returns are critical. But they are generally meaningless in the context of our discussion of diversification. Plus, good luck getting a concensus on projected returns.

3. With equal-weight, you are at a much greater risk of bubbles in smaller companies than in larger ones. With cap-weight, you face equal risk that any particular company is in a bubble.

4. No, I don't invest separately in REITs or SC Value. I do have a US "bias," but that's because I'm still grappling with how to deal with or ignore currency risk, which is not compensated. That's a discussion for another thread (or 20).
Well, G-Money,

1. The thread is about 50 stocks *dominating* the S&P 500 and I cited equal-weighing (RSP) as an alternative approach. Bets are made in Vegas, investment decisions are based on academic studies of what has existed in the markets and MAY exist in the future. See my response above of F/F 3 Factor Model. That said, as soon as my crystal ball starts working, I may start making bets on individual holdings.

2. Expected returns are NEVER meaningless in any context of financial planning. Otherwise, lets load on TIPs and go fishing.

3. :?

4. You are then a Total Market type -- terrific.
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Re: 50 Biggest Companies Dominate the S&P 500

Post by Beagler » Tue Dec 22, 2009 6:10 pm

YDNAL wrote: ...Expected returns are NEVER meaningless in any context of financial planning. Otherwise, lets load on TIPs and go fishing.
You're in august company.

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Post by Trev H » Tue Dec 22, 2009 6:33 pm

"With equal-weight, you are at a much greater risk of bubbles in smaller companies than in larger ones. With cap-weight, you face equal risk that any particular company is in a bubble"

Giving equal weight to Large and Small eliminates the risk of bubbles.

Investing in TSM only puts you at a great risk of bubbles specifically in large growth which dominates the cap weighted market.

If you look at history say from 1927 forward - the 10 year period where TSM performed best ended in 1999, if you look at the 10 year returns just 5 years later TSM underperformed everything else.

In the mid-to-late 70's SV outperformed everyting else, and that did not change in the next 5 or 10 years (not like it did for TSM).

TSM is the extreme in bubble risk.

Half Large, Half Small eliminates bubble risk.

Not talking about equal weighted indexes, but holding Large and Small and rebalancing yearly.

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Post by Fbone » Tue Dec 22, 2009 6:37 pm

Interesting how FGRTX (127 megacap) outperformed both S&P 500 and VTSMX for the last 3, 5 and 10 years according to M* chart.

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Post by jenol » Tue Dec 22, 2009 7:22 pm

New Zealand and USA should be equal weighted with the same ideology. Does that make sense?

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Post by peter71 » Tue Dec 22, 2009 7:40 pm

jenol wrote:New Zealand and USA should be equal weighted with the same ideology. Does that make sense?
Absent currency risk you could certainly make a case for some hypothetical low-cost equal weight fund with 2% each in 100 randomly selected stocks apiece from the 50 or so countries with at least 100 stocks available to buy. This would minimize political/fiscal/monetary/risk and give you tiny (but equal) chunks of 5000 different companies, with the price paid for those often small stocks presumed to be no less "correct" than the price paid for larger stocks . . . but it's about equally hypothetical as is a world made up of the US and New Zealand alone. :D

All best,
Pete

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Re: 50 Biggest Companies Dominate the S&P 500

Post by YDNAL » Sat Dec 26, 2009 1:29 pm

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Post by billspetrino » Sat Dec 26, 2009 1:42 pm

Great point about how the top 50 dominate the total 500

Obviously the multinational largest caps have the least chance of going Broke

The trick is to know what is an appropriate price for each company and how will that particular company will be"changed by technology" in the next 25 years

Unfortunately it is impossible to know for sure but obviously dell computer's future is much more uncertain than pepsi 's is

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Post by Rick Ferri » Sat Dec 26, 2009 1:50 pm

Cap weighted indexes measure the dollar value of a market or a segment of the market. They answer this simple question, "If I wanted to buy every share of every stock listed in the stock market, how much would I have to pay?"

There are many SPINdexerswho claim that market index funds are not a good choice for investors because market indexes are flawed. Flawed from what? Measuring market value? That cannot be true. Multiplying the number of shares outstanding by price is not a flawed measurement technique.

A market index measures the value of a market in dollar terms. No more and no less. If a person reads any more into it, then they are not asking the right question.

This argument that capitalization weighted indexes are a flawed investment strategy is also nonsense. The market does not make claim to being a superior investment strategy. It has only become one by default. The active strategies that benchmark their returns to the cap weighted market returns have failed investors over the years. Consequently, it is in the best interest of investors to not speculate on management skill, keep costs as low as possible, and keep turnover low also. That means using good ole cap-weighted index funds.

Rick Ferri

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Post by Beagler » Sat Dec 26, 2009 8:00 pm

Rick Ferri wrote:The market does not make claim to being a superior investment strategy. It has only become one by default.
"TSM is all you need?"
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cap weighted

Post by pkcrafter » Sat Dec 26, 2009 8:44 pm

Phew, thanks Rick. I had to scroll to the top to make sure I was on the right forum. :shock:

If the smaller companies in the market deserved more investor money, then the market would agree and reflect it. If you equal weight (overweight smaller companies), you should have a good fundamental reason for doing it. And no, the answer isn't because the larger companies get too much money.

In a sense, cap weighting is equal weighting. Each company gets the same percentage of $1 based on company size. A company 100x larger gets 100x more than the company 100x smaller. The investing method is unbiased and spreads the money evenly. Equal weighting does not.

If we each get a raise and I make $10,000 and you make $100,000, should I get $5000 and you get $5000? I'd like it, but you might wonder why I'm worth a 50% raise and you only get 5%. :)


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Re: cap weighted

Post by hafis50 » Sun Dec 27, 2009 5:16 am

pkcrafter wrote:Phew, thanks Rick. I had to scroll to the top to make sure I was on the right forum. :shock:

If the smaller companies in the market deserved more investor money, then the market would agree and reflect it. If you equal weight (overweight smaller companies), you should have a good fundamental reason for doing it. And no, the answer isn't because the larger companies get too much money...Paul
Even the Fundamental Indexers admit the potential flaws of equal-weighting.
But previous threads demonstrated that these arguments can be too "confusing" for some "academics":

Indexuniverse, Arnott...- Beyond cap weight:
One nuance that has received startlingly little attention in the academic and practitioner journals is: Equal weighting of what index? If cap weight has a bias toward including overvalued companies, then equal weight may exacerbate this bias. For instance, a clairvoyant might assert that the future prospects of 150 companies in the S&P 500 do not justify inclusion in the index. Their “clairvoyant value” market cap is too low. Because they will assuredly under-perform eventually, they will pull down the S&P 500 return relative to our mythical clairvoyant value portfolio. But, where these stocks might comprise 5-10 percent of the S&P 500, they comprise 30 percent of the S&P EWI. We have a possibly severe “selection bias” problem!
This reminds me of Perold's paper (in the Financial Analysts Journal) that was "rejected" here although it "had not been read".

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Post by DaleMaley » Sun Dec 27, 2009 10:00 am

We only have 6 years of data on equally weighted versus market cap (Rydex's RSP equally weighted fund started in 2003). So far, a pretty close horse race:

Image
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Post by Triple digit golfer » Sun Dec 27, 2009 10:05 am

DaleMaley wrote:We only have 6 years of data on equally weighted versus market cap (Rydex's RSP equally weighted fund started in 2003). So far, a pretty close horse race:

Image
But isn't that an apples to oranges comparison? You're comparing different portfolios with different risk levels.

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Re: cap weighted

Post by Rodc » Sun Dec 27, 2009 10:20 am

pkcrafter wrote:Phew, thanks Rick. I had to scroll to the top to make sure I was on the right forum. :shock:

If the smaller companies in the market deserved more investor money, then the market would agree and reflect it. If you equal weight (overweight smaller companies), you should have a good fundamental reason for doing it. And no, the answer isn't because the larger companies get too much money.

In a sense, cap weighting is equal weighting. Each company gets the same percentage of $1 based on company size. A company 100x larger gets 100x more than the company 100x smaller. The investing method is unbiased and spreads the money evenly. Equal weighting does not.

If we each get a raise and I make $10,000 and you make $100,000, should I get $5000 and you get $5000? I'd like it, but you might wonder why I'm worth a 50% raise and you only get 5%. :)


Paul
Hi Paul,

Isn't that a circular argument? Something like the larger companies should be larger because they are larger? Or since people piled more money into large companies they deserve to have people pile more money into them?

This is an issue that I have struggled with in the past. Is a company large because it sells lot of widgets, employs lots of people, has interests in many market segments, or is it large simply because it has a large market cap?

If I have a certain company and in a recession it has market cap of $10B, and then without making more widgets, without hiring more people, without going into more market segments, due only to market "sentiment" its market cap goes up by 50% over the course of a few months, is the company really 50% larger in some fundamental sense (what does that even mean?)? Or if a recession hits and the stock price drops, did the company really get smaller?

Tis puzzling. Market Cap is well defined. "Size" of a company not so much.

I do agree that market cap reflects market consensus, and thus is important. However to the degree that an individual is different from the market (which is heavily influenced by endowments, pension funds, active mutual funds which exist to make money for managers, hedge funds (which really exists to make money for managers), etc.) an individual may not want to follow the crowd completely.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Post by DaleMaley » Sun Dec 27, 2009 10:46 am

Triple digit golfer wrote:
DaleMaley wrote:We only have 6 years of data on equally weighted versus market cap (Rydex's RSP equally weighted fund started in 2003). So far, a pretty close horse race:

Image
But isn't that an apples to oranges comparison? You're comparing different portfolios with different risk levels.
Rydex's fund is based upon an equally weighted version of the S&P 500, as best as I can tell from their prospectus.

So comparing RSP to Vanguard's Index 500 should be a good comparison between equally weighted and market cap based approaches.

I threw in Vanguard's Total Stock Market fund just for comparison purposes. Yes, technically it is not fair to compare TSM to the S&P 500. However, if you look at the long term difference in return between TSM and the S&P 500, there is not a statistically significant difference (10 years + time frame).
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Post by Triple digit golfer » Sun Dec 27, 2009 11:19 am

Dale,

I think comparing an equal weight S&P 500 fund to the regular cap-weighted S&P 500 is apples to oranges because the equal weight fund is riskier (more money in smaller stocks). So, it should have a higher return, no? In a sense, this is similar to comparing a SV fund to TSM. SV should have higher returns because it is riskier and has expected higher returns.

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Post by Rick Ferri » Sun Dec 27, 2009 11:59 am

Indexuniverse, Arnott...- Beyond cap weight:

Quote: One nuance that has received startlingly little attention in the academic and practitioner journals is: Equal weighting of what index? If cap weight has a bias toward including overvalued companies, then equal weight may exacerbate this bias.


Pardon me for not agreeing with the King of SPINdexing, Rob Arnott. The only people who say that cap weighting is 'bias' are those marketing manipulators who profit handsomely if they can sell their spin to the public. Don't buy it. Neither fundamental weighting or equal weighting is 'indexing' as Jack Boggle sees it sense. These gimmicks exist for one reason - to extract higher management fees from investors.

Rick

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Post by hafis50 » Sun Dec 27, 2009 12:52 pm

Rick Ferri wrote:
Indexuniverse, Arnott...- Beyond cap weight:

Quote: One nuance that has received startlingly little attention in the academic and practitioner journals is: Equal weighting of what index? If cap weight has a bias toward including overvalued companies, then equal weight may exacerbate this bias.


Pardon me for not agreeing with the King of SPINdexing, Rob Arnott. The only people who say that cap weighting is 'bias' are those marketing manipulators who profit handsomely if they can sell their spin to the public. Don't buy it. Neither fundamental weighting or equal weighting is 'indexing' as Jack Boggle sees it sense. These gimmicks exist for one reason - to extract higher management fees from investors.

Rick
I totally agree.
And that's why I made a reference to Perold's paper that rejected the notion of biased cap-weighted indices.

But the argument against equal weighting seems to be valid IMO.
I was always ridiculed when I made this (Arnott's and Perold's) argument against equal-weighting..
Critics of fundamanental indexing may add that such arguments against equal-weighting are also arguments against "fundamental" indices.

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