4 ms·

Yes there's an index committee comprised of humans. But the index methodology is public and when there are tie break decisions needed, they're fairly predictabl

by anonu 4y ago

Yes there's an index committee comprised of humans. But the index methodology is public and when there are tie break decisions needed, they're fairly predictable. Another thing to think about is that most of the outperformance of the index is driven by the largest companies. But not because they were added when they were their current size. But because of the buy and hold approach of getting them in when they're still on the small end of the large caps. There was a good recent paper on this concept, showcasing that most of the big index returns are attributable to only a few stocks. Similar to how most of global market returns are mostly just US.

herostratus101 4y ago
I think you mean that the committee comprises humans.
somethoughts 4y ago
Definitely agree the algorithm is likely pretty well documented but as noted in the blog it is adapted in realtime. Here's the current breakdown: Apple 7.08%, Microsoft 6.20%, Amazon.com 2.62%, NVIDIA 1.87%, Alphabet 1.84% Berkshire 1.65% Alphabet 1.61% Tesla 1.44% which if it was an active manager would be highly opinionated.
- singhrac 4y ago
  Really? That's essentially just the market cap weights, which is the most default thing you could do. There's a slight deviation because it's float-adjusted and I'm assuming their marks are at some frequency, but those numbers aren't mysteries.
  - pavlov 4y ago
    I think the point is that the divergence in market cap is so large that it’s become equivalent to a highly opinionated active manager. Any fund that’s allocating over 13% to just two companies seems a bit risky, but that’s what you’re getting with Apple and Microsoft here.
    - sokoloff 4y ago
      I don’t think it’s as opinionated nor active as you’re making it out to be. Investing proportionally more in a huge company than you do in the 500th largest eligible company seems much more passive than active to me. If two S&P companies were to merge and everything else remained the same, I’d think that having the combined amount invested in the combined company to be more sensible than cutting your investment proportion in half merely by a merger. Or if a company you’d invested in doubled in value, I’d rather hold the constant number of shares rather than sell half of them to bring my exposure to the winner down. I’d also view that as passive and un-opinionated. Selling half feels more active and opinionated than simply holding.
    - deleted 4y ago
      [deleted]
    - singhrac 4y ago
      I’m sorry, but this is just not true. Active managers are measured by their deviation from the S&P (i.e. a beta 1 manager is extremely passive). This index has also always been concentrated to some extent, so not sure it’s any kind of recent change. I think maybe you are talking about risk, but it’s a completely separate idea.
- DesiLurker 4y ago
  unrelated basic question: Berkshire itself is a conglomerate that owns oprtions of S&P companies like Apple etc. So is this not double dipping?
- skybrian 4y ago
  I was confused by NVIDIA having a similar weighting to Alphabet despite having less than half the market cap. But notice that Alphabet appears twice. (GOOG and GOOGL.)
88913527 4y ago
Is the algorithm "select * from companies order by market_cap desc limit 500"? At the risk of oversimplifying, there should be quite little to debate, and when some hair-splitting occurs, I trust a committee of reasonable humans will make a reasonable choice.
- mandevil 4y ago
  The algorithm is a little more complicated than that, as various judgements have been added in, but always with specific rules. When there was a trend of tech companies going public with dual classes of shares leaving founders in control forever (e.g. Zuck with Facebook) they announced that any company which went public after date X with dual classes to prevent the economic owners from exercising control would not be allowed onto the index. Similarly, there are rules about profitability that, IIRC, were added after the first dotcom bubble to try and keep extreme bubbles from mucking up the index (I think it's that you need to have two consecutive quarters of profitability, but I don't remember the details). Also, the market cap of company 450 and company 550 are close enough that recent market performance can flop ]back and forth fairly regularly, which the S&P has further rules to try and limit, though again I don't remember the details. Again, they try to be fairly rules based, but do exercise some discretion in creating the rules.
- anonu 4y ago
  You have to adjust for free float market cap. Companies need to be US incorporated. You have to be aware of share classes. For example both GOOG share classes are in the S&P. When it comes to tiebreak decisions, there may be 5 or so potential adds when there is 1 delete. There may be a focus on evening out sector exposures, preferencing underweight sector adds. (Just my guess)
jackcosgrove 4y ago
That's interesting. I was contacted by a personal money manager looking for clients and he explained his philosophy as sampling 30-50 stocks from the top end of the S&P 500. He had outperformed the market during a bull run, which I attributed to the increased risk of a smaller portfolio. I didn't invest because I figured his fund would underperform the index during the next bear run for that same reason, canceling out the gains and moreso with fees. Maybe there actually was something to his strategy; I haven't followed up on his performance.
- robocat 4y ago
  Owning a handful of shares does capture a significant amount of the beta for a market. However with very significant profitability outliers, such as power law distributions, then you have to own all the shares to ensure you don’t miss out on the one or two shares that make up most of the gains. Venture capitalists talk about this a lot. Historically the same issue occurred with market timing: most market gains are made during only a few relatively short unpredictable periods. You need to own shares for a long time to ensure you are in the market when those few unpredictable ups occur.
- bombcar 4y ago
  IIRC many active managers beat the market/S&P 500/benchmark before fees. It's almost impossible to beat after fees because the fees are too much of a drag.

by anonu 4y ago

herostratus101 4y ago

I think you mean that the committee comprises humans.

somethoughts 4y ago

Definitely agree the algorithm is likely pretty well documented but as noted in the blog it is adapted in realtime. Here's the current breakdown: Apple 7.08%, Microsoft 6.20%, Amazon.com 2.62%, NVIDIA 1.87%, Alphabet 1.84% Berkshire 1.65% Alphabet 1.61% Tesla 1.44% which if it was an active manager would be highly opinionated.

singhrac 4y ago
Really? That's essentially just the market cap weights, which is the most default thing you could do. There's a slight deviation because it's float-adjusted and I'm assuming their marks are at some frequency, but those numbers aren't mysteries.
- pavlov 4y ago
  I think the point is that the divergence in market cap is so large that it’s become equivalent to a highly opinionated active manager. Any fund that’s allocating over 13% to just two companies seems a bit risky, but that’s what you’re getting with Apple and Microsoft here.
  - sokoloff 4y ago
    I don’t think it’s as opinionated nor active as you’re making it out to be. Investing proportionally more in a huge company than you do in the 500th largest eligible company seems much more passive than active to me. If two S&P companies were to merge and everything else remained the same, I’d think that having the combined amount invested in the combined company to be more sensible than cutting your investment proportion in half merely by a merger. Or if a company you’d invested in doubled in value, I’d rather hold the constant number of shares rather than sell half of them to bring my exposure to the winner down. I’d also view that as passive and un-opinionated. Selling half feels more active and opinionated than simply holding.
  - deleted 4y ago
    [deleted]
  - singhrac 4y ago
    I’m sorry, but this is just not true. Active managers are measured by their deviation from the S&P (i.e. a beta 1 manager is extremely passive). This index has also always been concentrated to some extent, so not sure it’s any kind of recent change. I think maybe you are talking about risk, but it’s a completely separate idea.
DesiLurker 4y ago
unrelated basic question: Berkshire itself is a conglomerate that owns oprtions of S&P companies like Apple etc. So is this not double dipping?
skybrian 4y ago
I was confused by NVIDIA having a similar weighting to Alphabet despite having less than half the market cap. But notice that Alphabet appears twice. (GOOG and GOOGL.)

88913527 4y ago

Is the algorithm "select * from companies order by market_cap desc limit 500"? At the risk of oversimplifying, there should be quite little to debate, and when some hair-splitting occurs, I trust a committee of reasonable humans will make a reasonable choice.

mandevil 4y ago
The algorithm is a little more complicated than that, as various judgements have been added in, but always with specific rules. When there was a trend of tech companies going public with dual classes of shares leaving founders in control forever (e.g. Zuck with Facebook) they announced that any company which went public after date X with dual classes to prevent the economic owners from exercising control would not be allowed onto the index. Similarly, there are rules about profitability that, IIRC, were added after the first dotcom bubble to try and keep extreme bubbles from mucking up the index (I think it's that you need to have two consecutive quarters of profitability, but I don't remember the details). Also, the market cap of company 450 and company 550 are close enough that recent market performance can flop ]back and forth fairly regularly, which the S&P has further rules to try and limit, though again I don't remember the details. Again, they try to be fairly rules based, but do exercise some discretion in creating the rules.
anonu 4y ago
You have to adjust for free float market cap. Companies need to be US incorporated. You have to be aware of share classes. For example both GOOG share classes are in the S&P. When it comes to tiebreak decisions, there may be 5 or so potential adds when there is 1 delete. There may be a focus on evening out sector exposures, preferencing underweight sector adds. (Just my guess)

jackcosgrove 4y ago

That's interesting. I was contacted by a personal money manager looking for clients and he explained his philosophy as sampling 30-50 stocks from the top end of the S&P 500. He had outperformed the market during a bull run, which I attributed to the increased risk of a smaller portfolio. I didn't invest because I figured his fund would underperform the index during the next bear run for that same reason, canceling out the gains and moreso with fees. Maybe there actually was something to his strategy; I haven't followed up on his performance.

robocat 4y ago
Owning a handful of shares does capture a significant amount of the beta for a market. However with very significant profitability outliers, such as power law distributions, then you have to own all the shares to ensure you don’t miss out on the one or two shares that make up most of the gains. Venture capitalists talk about this a lot. Historically the same issue occurred with market timing: most market gains are made during only a few relatively short unpredictable periods. You need to own shares for a long time to ensure you are in the market when those few unpredictable ups occur.
bombcar 4y ago
IIRC many active managers beat the market/S&P 500/benchmark before fees. It's almost impossible to beat after fees because the fees are too much of a drag.