Mutual Funds > Zweig on Funds
Is the S&P 500 rigged?
June 13, 2001

The ultimate market measure has been turned inside out -- and may never be the same again. Investors beware
By Jason Zweig
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Many investors think that Standard & Poor's 500-stock index, the most popular benchmark for measuring market performance, is a stable list of the country's 500 biggest companies. Not so. The S&P 500 is, in fact, made up of the 500 stocks that most appeal to seven people who meet once a month on the 44th floor of 55 Water Street in downtown New York City. Like the admissions committee of an elite country club dropping white or black balls into a wooden box, the Index Committee of Standard & Poor's meets in secret; its proceedings are at least as private as those of the Federal Reserve Board, with no minutes released or memorandums issued. But it's become clear that the index keepers are changing the S&P in a radically new and potentially disruptive way. They are systematically tearing out sluggish Old Economy value stocks and replacing them with trendy New Economy names. The implications for investors are huge. One example: The switches made last year hurt the performance of the index by an estimated total of $100 billion.

Vast sums of money ride on the S&P index committee's deliberations. The S&P 500 makes up about 70 percent of the value of all U.S. stocks; roughly $1 trillion is invested in index funds that seek to track its performance precisely, with trillions more in other funds that shadow it. To sophisticated investors, the S&P 500 is the market.

When the S&P committee replaces one stock and adds another, it issues a terse press release at 5:15 p.m. New York time, after the stock market closes. Only then does an S&P official contact the companies that have been added and deleted. The announcement sets off a huge chain reaction, as the index funds swing into action, buying the new stock in massive volumes. By the end of the first day a stock is included in the S&P 500, roughly 8 percent of its shares disappear into the portfolios of index funds, where they remain indefinitely. Non-index funds load up on a newly minted member as well, betting that the stock's price will rise now that it has joined the ultimate honor roll for American companies. Meanwhile, the shares that the committee deletes from the index drop that day like ducks shot out of the sky.

"The idea in running the index," explains index committee chairman David Blitzer, "has always been that it should reflect the stock market and, through the market, the U.S. economy as a whole." Blitzer, an affable and refreshingly forthright fellow who looks like a blend of an Amish farmer and a rabbi, is S&P's chief investment strategist and the author of a solid new book on index funds, Outpacing the Pros.

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