maybe OT : question re addition/removal to/from any index :
- in the long term, why / how does it matter ?
from the VTSS thread:
HOW MANY STOCKS IN THE S&P500?
Yes, people do ask, so here are the answers to that and other frequently asked questions about the S&P 500 Index.
By
David M. Blitzer
Vice President and Chief Economist, Standard & Poor's
Chairman, Standard & Poor's Index Committee
The two questions most often asked about the S&P 500 are, "How come it's so hard to beat?" and "How many stocks in the S&P
500?"
No kidding, we do get a lot of calls asking how many stocks are in the index and some people aren't sure the answer is 500. More
seriously, since the S&P 500 is the universal benchmark for judging money managers and since some $700 billion is directly
linked to it through index funds, there are good reasons for investors to be curious about it.
The S&P 500 dates back to 1926, and to 1957 in its present form with 500 stocks. It is not the largest or even the best 500 stocks.
Rather, the S&P 500 includes stocks selected by Standard & Poor's Index Committee to include leading companies in leading
industries and to reflect the US stock market.
The S&P 500 is the U.S. component of the S&P Global Index. Other building blocks in the new S&P Global Index include the
S&P Euro and Euro Plus for Continental Europe and the S&P/TSE 60, developed with the Toronto Stock Exchange, for Canada.
New S&P indices for the UK, Latin America, Japan and the Asia/Pacific region will be unveiled soon. This is in keeping with the
primary purpose of Standard & Poor's Financial Information Services to provide the world with objective knowledge and advice,
creating the opportunity for building wealth.
Why is the S&P 500 so Hard to Beat?
It is possible to outperform the S&P 500; a number of money managers do it in any year or period of years. But, as many know, it
is hard to beat it consistently. In a search of Standard & Poor's mutual fund data, only 14 diversified equity funds beat the index's
annual return of 22.98% for the five years ending with November, 1998.
The index numbers are impressive. In the five years through November, 1998, the S&P 500 returned 181.30%, including
reinvested dividends. This is an average annual return of 22.98%. If you had put money in the S&P 500 35 months ago, it would
have doubled as of the end of November.
And investors can achieve the index's performance in any of a number of index mutual funds that mirror the S&P 500. One of
S&P's goals is that our indices be "investable" - so people can easily own all the stocks in the index and obtain virtually the same
results as the index.
We don't know exactly why the S&P 500 is hard to beat. We do know that some times it is harder to outperform than other times.
When large cap stocks beat small cap stocks, as they have in the last few years, the S&P 500 easily beats its mid cap and small cap
brethren, including the S&P MidCap 400 and SmallCap 600 indices. While we don't have some secret formula for why the index
does well, we can offer some possible explanations.
Mergers and the "list" effect. One of the big factors in the market in recent years are mergers that run up the prices of target
companies. For an investor, holding a stock when it is taken over is fast route to investment success. The S&P 500 is a great list of
merger candidates - the companies are well known and widely followed on Wall Street. The list is one of the first places an
investment banker turns when searching for a big target.
Momentum effects. One of the adages of Wall Street is to cut your losses and let your profits run. If you could constantly
rebalance your portfolio so that more of your money was in the winning stocks and less was in the losers, your portfolio would
ride momentum higher and higher. Because the S&P 500 is capitalization-weighted that is exactly what happens. The index holds
each stock in proportion to its total value, or market "capitalization," in the stock market. Therefore, if a stock surges in price, its
market capitalization rises and its share in the S&P 500 climbs. Likewise, if a stock tumbles, its market value and its weight in the
index both decline.
Low Turnover. Most Monday-morning quarterbacking reports on investing argue that most investors trade their own accounts far
too much, often selling stocks that are still rising. Standard & Poor's does make changes in the index, most often because of
mergers, acquisitions, spin-offs and other such developments. As a result, trading costs and capital gains tax exposure are
minimized.
A Myth Exploded: "Index Effect" Doesn't Boost Index Performance
One factor that does not boost the index's performance is the "index effect." The index effect is the tendency of stocks to run-up
when Standard & Poor's announces that they are about to be added to the S&P 500. A rise of 3% to 6% in price over a few days
following the news is typical. The price rise is generated by index funds buying the stock and by arbitrageurs trying to create a
market squeeze and profit from it.
Standard & Poor's doesn't want to move the market. Several years ago, in an effort to reduce potential market impact, we began
making our announcements a few days in advance rather than waiting until the last minute.
While the index effect may be exciting, it doesn't go into the numbers we report. If we announce that a stock will be added after the
market close five days from now, the index effect will play out over the next five days. But the price used for index calculations is
the closing price on the fifth day, the day it is actually added. Any price run-up happens before the stock joins the index and the
index numbers don't benefit from it.
How Do Stocks Get Into The S&P 500?
Since we're talking about the "index effect," a logical question is "How do stocks get into the index?"
The Standard & Poor's Index Committee makes all the decisions about the S&P 500. The Index Committee is made up of
Standard & Poor's professionals with many years of experience, not only with indices, but also with the capital markets. Naturally,
neither companies nor any other Standard & Poor's clients play a role in the decision-making process.
Partly because the Committee must keep its discussions confidential, its work is not well understood. However, there are some
general guidelines and practices that are used in managing the S&P 500.
First, the index is viewed as the leading companies in leading industries in the U.S. markets and a reflection of the U.S. stock
market. It also generally reflects the composition of the economy, except that some parts of the economy are never included in the
stock market. Law firms, for instance, are big business in the U.S., but since there are no publicly traded law firms, this sector is
not represented in the S&P 500. Of course, since most of the companies in the index have large legal departments, there is some
coverage for legal services.
Second, the S&P 500 consists of U.S. companies. There are a handful of non-U.S. companies that have been in the index for
decades and are "grandfathered," meaning they will stay in the index since they have been in for so long. But, these would not be
added today. Recently, when Chrysler was acquired by Daimler-Benz to form DaimlerChrysler, Standard & Poor's reviewed this
issue again and decided to maintain its policy of adding only U.S. stocks to its U.S. indices.
Third, Standard & Poor's tracks different market sectors - consumer cyclicals, health care, transportation, technology, etc. - and
analyzes how they are represented in the index and in the market. Sector composition is considered in selecting new companies for
the index. But when a stock is dropped from the index, its replacement won't necessarily come from the same sector.
Fourth, the Index Committee looks at trading liquidity to assure that investors can buy the stocks selected for the index.
Closely-held stocks where a small group has control of a company will often be excluded from consideration for the index.
Finally, a rigorous fundamental analysis is performed on selected stocks. Since minimizing index turnover is a goal, S&P seeks to
add only relatively stable stocks to the S&P 500.
All these considerations come together at the Index Committee's regular meetings. At each meeting, pending corporate actions such
as mergers or spin-offs that involve companies in the index are reviewed. Decisions on the exact changes in the index are made and
replacements are selected. The replacements are kept secret until a public announcement is made. On rare occasions, there may be
unusual trading activity in a stock slated to be added to the index due to investor speculation. When this happens, we sometimes
change our selection before the public announcement.
Normally, announcements are made at about 5:15 PM New York Time and are released to the public by the major wire services
and posted on the S&P Index Services web site - www.spglobal.com. Only after the public is informed are Standard & Poor's
clients or the companies involved notified.
One More Time -- How Many Stocks in the S&P 500?
So there you have it. The S&P 500 is sometimes shrouded in great mystery, often created by frustrated money managers who
haven't been able to beat it in recent years. We have also contributed to the mystery, although unwittingly, because of our need to
keep the Index Committee's activities confidential.
It's not easy to beat, but investors around the world have chosen the S&P 500 as the standard representative of the U.S. market
precisely because of the care we take in making sure it effectively reflects the market. Over 400 financial institutions worldwide are
licensed to create S&P index-linked investments. No index is more widely used than the S&P 500.
And yes, the answer really is 500. |
