Structure Matters: Blitzer On Index Changes

February 25, 2014

Blitzer (cont'd.): The third Friday of the last month of the quarter is triple-witching Friday—the 20th of December in 2013. There is a huge amount of trading because index futures and options expire on that day. Those days are often good choices for large index changes because of the liquidity in the market.

When we decided to add Facebook—coincidentally on Friday the 13—we made the decision to provide seven days’ notice, more than the usual five days’, because we knew that the move would be perceived as an important addition.

Weiskopf: When a stock is added to the index, what determines its weight in the index?

Blitzer: The S&P 500, and most other indices, are market-cap-weighted, meaning each company’s weight is based on its market capitalization or value. A company’s value is the price of its stock multiplied by the number of shares. Its weight in the index is equal to its market value divided by the sum of the market values of all the companies in the index.

Three things about this approach: First, if a company’s stock price rises faster than the index rises, that company’s weight in the index increases and other companies’ weights decrease. Second, the index weights adjust to price changes all the time. Third, the S&P 500 and most other indices are float-adjusted, meaning we only count shares that are available to investors, the “float.”

For example, the Walton family owns a large part of Walmart, so their shares are excluded from the float and the index. In Facebook’s case, the weighting amounted to about 50 basis points.

Weiskopf: What made you remove Teradyne to make room for Facebook?

Blitzer: We run three indices—actually, we run thousands of indices, but we’ll talk about three—the S&P 500, which is usually viewed as large cap; the S&P MidCap 400; and the S&P SmallCap 600. From time to time, some companies do a little bit better or a little bit worse than typical in the index, and every so often it comes time to sort of shift a few names.

The announcement we made about adding Facebook to the S&P 500 included other changes to the S&P 500 as well as the S&P MidCap 400 and the S&P SmallCap 600. Teradyne was a company that hadn’t grown its market cap quite as fast as the 500 had overall, and was more appropriate for S&P Midcap 400.

This shifting, promoting and demoting, is an index change and is not an investment recommendation. Choosing a company for an index is not an investment opinion about the company.

Weiskopf: In the fixed-income area, what are the rules for removing credit from an index after it has been downgraded? Do all index providers follow the same standards?

Blitzer: Each index provider sets its own rules when it develops an index. Our index methodologies include the ratings required for a bond to be included in an index. The most common thing is to say it has to be investment grade, which would either mean BBB- and above, or BAA three and above, depending on which rating agency you're looking at.

Index methodologies usually cite two or three major rating agencies—Standard & Poor’s Ratings Services, Moody’s and Fitch—and will use the lowest rating among the agencies to qualify a bond. To be clear—S&P Dow Jones Indices operates separately from Standard & Poor’s Ratings Services.

Neither S&P DJI nor Standard & Poor’s Ratings Services has any access to any unpublished or private information that the other may have. We are walled off from one another. We are rating-agency neutral.


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