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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.
NEXT: Beneath the surface>>
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