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The Truth Behind the S&P 500, Part 2

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Image used under license from Shutterstock.com

The S&P 500 is perhaps the largest “managed” fund in the world. Contrary to widespread belief, it is not an index of only the largest companies in America by market-cap as I explain here. It is an index comprising 500 stocks that are actively chosen by a committee.

The committee, led by economist David Blitzer picks 500 stocks from a listing of 1,000 of the largest companies in America. It also decides the sectors and the sector-weightings.

In the late 90s, for example, when technology was on fire, the committee finally decided to make technology its own sector. The committee had already missed a huge run up in the sector, but with its ninth inning move, investors were there in spades when tech went bust in 2000. Maybe not the best stock selection move by the committee.

The committee’s stock selection methodology includes a company’s public float, financial viability, and treatment of IPOs to name a few. When AIG was “rescued” by the government, for example, public float sank well below the 50% guideline. But, rather than cut AIG loose, the committee decided to keep it in the index. That was their choice.

Today the committee needs to consider what to do about Amazon. How does the committee choose which sector Amazon should be in when it is basically in almost every sector? It’s in cloud services, groceries delivered to your kitchen, and will command an estimated 43.5% of e-commerce sales this year. The committee considers Amazon as a consumer-discretionary. Really? Meanwhile Wal-Mart is a consumer-staple. As Mr. Blitzer has said in the past, “At the end of the day, it’s more art, not a science.”

When it comes to constructing portfolios for clients, I agree that stock selection is more art than science—it’s a guiding tenet for what we do for investors. But with so many trillions of dollars banking on the S&P 500’s “passive” approach, perhaps “managed” would be a more accurate description.

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E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com