Swedroe: Is The S&P 500 Actively Managed?

August 06, 2014

The world’s most-followed benchmark isn’t as passive as you think.

In Mebane Faber’s new book, “Global Value,” he states: “It is ironic that the largest and most famous index, the S&P 500, is really an active fund in drag. It has momentum rules (market cap weighting), fundamental rules (four quarters of earnings, liquidity requirements) and a subjective overlay (committee input). Does that sound passive to you?”

While we could debate extensively whether or not the S&P 500 Index is actively managed, I agree that it is. For me to consider the S&P 500 passive, it would have to comprise the top 500 stocks by market capitalization or, failing that, use rules-based screens with no reliance on the subjective judgments of committee members.

With that said, the real question is, Why does it matter if the S&P 500 is actively or passively managed? One reason the distinction might be important is because of an argument often raised by supporters of active management. They contend that the S&P 500 is not a fair benchmark because it’s really an actively managed index. Let’s examine if that claim has any validity.

Is The Benchmark A Good One?

Unlike the CRSP (Center for Research in Security Prices at the University of Chicago) and Russell indices—which are based purely on objective measures, such as market capitalization—the S&P 500 is selected by a committee at S&P Dow Jones Indices headed by David Blitzer. As such, the index changes—new companies are added and old ones are deleted—on a fairly regular basis. For example, nearly one-third of the index components changed between January 2000 and June 2005.

To determine if the “charge” that the index is incorrectly used as a benchmark has any validity, we can compare the returns of the S&P 500 to completely unmanaged indices. The Russell 1000 Index, started in 1979, is an index of the 1,000 largest companies. For the 35-year period ending in 2013, the Russell 1000 returned 12.03 percent per year and the S&P 500 returned a virtually identical 11.96 percent per year.

Another good benchmark for the S&P 500 is the CRSP Index of large-cap stocks, which uses deciles 1-5 of all stocks ranked by market capitalization as determined by NYSE stocks. Since the S&P 500 began life in 1957, we can compare the returns of the two indices for the 57-year period ending in 2013. Again, we find that the two indices provided virtually identical returns. The S&P 500 returned 10.06 percent per year and the CRSP 1-5 returned 10.12 percent per year.