Is Tracking S&P500 Really Passive Investing?

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norak
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Is Tracking S&P500 Really Passive Investing?

Post by norak » Fri Apr 23, 2010 1:53 am

I have been reading the Wikipedia article on S&P500 and in the "selection" section of the article it claims that the members of the S&P500 are selected by a committee of Standard & Poors staff. They make judgment calls about whether company stocks should go in and out based on the liquidity of the stock and then they adjust for industry representation so that all industries are covered. To me the way that this committee selects stocks to be in the index seems similar to active management.

Is anyone concerned about this? This committee of executives who choose which stocks are in or out of the index have a lot of power and the management fees that we pay for our index funds goes to these people indirectly because funds management firms must pay Standards & Poors for use of this index.

mikenz
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Post by mikenz » Fri Apr 23, 2010 2:25 am

I think it's passive enough, given that they aren't chasing hot sectors and moving stocks in and out of the index as a truly active manager would. But sure, they are making choices of what's in and out.

Most index funds have some discretion too. Vanguard's 500 index won't necessarily hold every company in the index, at least not in the exact proportion. They must try to match the performance of the index as closely as possible while keeping costs to a minimum.

I'm sure other index funds are based on indexes that are arbitrarily chosen. Bond funds are technically managed funds.

If the S&P started adding a lot of emerging market companies, or bonds, or dropped financial stocks, due to current market conditions, in order to boost the index temporarily, then I'd worry. As long as it's a stable index that is representative of large cap US stocks and that doesn't change, then I think it's appropriate to use for an index if you want that asset class.

Gekko
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Post by Gekko » Fri Apr 23, 2010 5:22 am

VG Index 500 Turnover rate (as of fiscal year end December 2009) = 11.5%

-----

According to Morningstar, the average mutual fund has an 89% annual turnover ratio. However, some funds on both ends tend to lean toward extremes. The chart below shows Morningstar's current five highest-turnover funds.

Fund
Annualized Turnover

Direxion Commodity Bull 2X Fund (DXCLX)
8,528%

Direxion HCM Freedom Fund (HCMFX)
3,065%

Direxion Spectrum Equity Opportunity Fund (SFEOX)
2,310%

Rock Canyon Top Flight Fund (TOPFX)
2,052%

Access Flex High Yield Fund (FYAIX)
1,900%

Yikes! That's a lot of buying and selling. That 8,528% turnover figure means that the Direxion Commodity Bull 2X Fund has been buying and selling its entire asset value about once every four days.

http://www.fool.com/investing/mutual-fu ... nover.aspx

Rodc
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Post by Rodc » Fri Apr 23, 2010 6:44 am

It is not the best, but not too bad.

I prefer to hold a non-committee based index funds, but if that were my best option in my 401K I would not worry about it: close enough.
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anthau
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Post by anthau » Fri Apr 23, 2010 7:47 am

To steal a line from Rick Ferri, once you have more than a few hundred stocks involved, it doesn't matter whether it's a committee or chimpanzees who are picking them.
Best, | | Anth

MrMatt2532
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Post by MrMatt2532 » Fri Apr 23, 2010 7:57 am

I'm sure you agree that investing in the total stock market is passive investing. Have you compared the SP500 with the total stock market lately? Their behavior is highly correlated and their long term returns are very similar.

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nisiprius
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Post by nisiprius » Fri Apr 23, 2010 8:01 am

I've seen active-fund boosters attack index investing by claiming that The S&P 500 is a mutual fund and a bad one. The pitch is that when you buy an S&P 500 index fund you're effectively buying an actively managed fund anyway, so now that we've undercut your rationale, let's go pick just the good stocks.

The easiest reply is that the S&P's idiosyncratic quirks are negligible--but if you don't like it, don't buy it. Buy a better index.

After all, Vanguard offers the Vanguard Large-Cap Index Fund (VLACX, 0.26% ER) that tracks the MSCI US Prime Market 750 Index. (No, I'm not sure what that index is. I'm too lazy to look it up. I assume it's selected more objectively, purely on the basis of capitalization, without the S&P beauty-contest aspects.) Does it make much difference? You tell me.

Image

And then of course there's always Vanguard Total Stock Market Index, VTSMX, let's add that in. Is there much difference between any of these three funds? Does it matter deeply which you choose? You tell me.

Image

VLACX has only been around for five years, but Morningstar lets us compare the VTSMX and Vanguard Five Hundred Index Fund (VFINX) all the way back to the start of VTSMX.

Image
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Re: Is Tracking S&P500 Really Passive Investing?

Post by YDNAL » Fri Apr 23, 2010 8:44 am

norak wrote:I have been reading the Wikipedia article on S&P500 and in the "selection" section of the article it claims that the members of the S&P500 are selected by a committee of Standard & Poors staff. They make judgment calls about whether company stocks should go in and out based on the liquidity of the stock and then they adjust for industry representation so that all industries are covered. To me the way that this committee selects stocks to be in the index seems similar to active management.
You always have the MSCI indices.
MSCI US Prime Market 750 Index (VLACX)
MSCI US Mid Cap 450 Index (VIMSX)
MSCI US Small Cap 1750 Index (NAESX)
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raddle
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Post by raddle » Fri Apr 23, 2010 8:47 am

I guess that depends. Are you actively engaged in the operation of all 500 companies?

gw
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Post by gw » Fri Apr 23, 2010 8:57 am

The point is that it's cheap. Apparently the S&P committee is passive enough that Vanguard can track its index with expenses on the order of 0.07%.

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Taylor Larimore
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How S&P selects its indexed securities

Post by Taylor Larimore » Fri Apr 23, 2010 9:54 am

Hi Norak:

You can read details of how the S&P selection committee selects U.S. securities for their indexes here:

http://www2.standardandpoors.com/spf/pd ... gy_Web.pdf

David Blitzer, Chairman of the S&P Selection Committee, has made several posts on this forum.
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stratton
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Post by stratton » Fri Apr 23, 2010 7:08 pm

nisiprius wrote:I've seen active-fund boosters attack index investing by claiming that The S&P 500 is a mutual fund and a bad one. The pitch is that when you buy an S&P 500 index fund you're effectively buying an actively managed fund anyway, so now that we've undercut your rationale, let's go pick just the good stocks.
If it so "bad" how come actively managed funds, where the S&P 500 would be an appropriate benchmark, have such a hard time beating it?

If I saw an article like that from someone at a company where I had money invested I would move the funds pronto!

I wouldn't trust any SEC filings by those people.

Paul

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sometimesinvestor
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Post by sometimesinvestor » Fri Apr 23, 2010 10:32 pm

I am not skilled enough to verify a theory with plots but based on what I know about the market since 1970 , bull markets end with overweighting of some type of stock (think the nifty 50 in the early 70s , the energy emphasis in the late 70s early 80s ,the tech bubble at the end of the 20th century. Though the s+p 500 went down in 2000 I believe the equally weighted 500 had a gain.Some etfs have been developed based on this issue.
If this bull market is still ongoing two years from now it might be sensible to try an equally weighted index at that time. I have no idea what the "popular sector will be in three years but am guessing it will contain a significant number of over valued stocks.

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