Practically every investment portfolio statement or mutual fund report you have ever seen references the S&P 500 index. It sticks to the corner of the TV screen on every cable news channel, and is the first or second statistic reported each morning on every financial page. So what is this ubiquitous magical number, and why does it garner such attention?
Beginning in the 19th century, investors began seeking some type of benchmark against which their own holdings could be judged. In 1884, Charles Dow created a basket of 11 transportation stocks, known as the Dow Jones Transportation Index. Many others followed. In 1926, the Standard Statistics Company created an index consisting of 90 stocks, recomputed daily. The company merged in 1941 with the Poor’s Publishing Company to become Standard and Poor’s, and expanded its index in 1957 to include 500 stocks and ultimately claim the title of most widely utilized metric the US stock market.
According to Standard and Poor’s, $11.2 trillion in managed assets are benchmarked to or created to mimic the S&P 500 index, with over $4.6 trillion directly indexed to it. Due to the method of its construction, the index covers roughly 80% of the total dollar value of the US stock market.
The makeup of the index is the responsibility of a committee at Standard and Poor’s charged with reflecting the overall makeup of the US economy. The bucket typically holds between 495-505 names (currently 505), which must meet defined criteria for inclusion. A company must have a certain minimum size, and at least 50% of its stock must be openly trading in the market. The index is rebalanced each quarter, but data is compiled and reported publicly in real time.
Each of the 500 or so companies is not equally represented in the S&P 500. Instead, the index is market cap weighted, meaning that the bigger a company is, the greater its percentage of the index relative to all others. The largest member, Microsoft, makes up fully 6% of the index with a market cap (total market value of outstanding shares) of $1.6 trillion. Bringing up the rear is beauty products maker Coty Inc. with a value of $3.4 billion, barely measurable at less than 1/100 of 1 percent of the S&P.
Precisely because the index is market cap weighted, a handful of the largest companies dominate and tend to pull the broader index along. As of June 30, the top 10 names make up fully 27% of the total value, including all the likely suspects: Microsoft, Apple, Amazon, Google and Facebook.
The S&P 500 is also divided into 11 sector subsets known as GICS or Global Industry Classification Standard assignments. Not surprisingly, the largest sector in the index today is Information Technology, comprising 27.5% of the total. Prior to the financial crisis of 2007, financial companies like banks dominated at 23% but now make up just 10% of the index. The smallest categories include Real Estate, Energy and Materials with less than 3% each, casting an interesting light on the changing composition of the US economy.
Market cap weighting has its critics, who rightly observe that larger companies are heavily over weighted and impart a growth bias to the index. Some have advocated for equal weighting (same dollar value of each stock), which would place greater emphasis on smaller companies and effectively act as more of a value index. Still others have launched “fundamental-weighted” indices that use performance metrics like PE or Price to Book value as weighting factors. Academic work continues, but actual investment results based on these alternative methods have been mixed.
For now, the S&P 500 is here to stay. In a sea of over 5,000 different indices in the US alone and the rapid rise of passive investing tied to broad market performance, the familiar benchmark is likely to retain its title as most familiar and useful of the market metrics in use.
Christopher A. Hopkins, CFA