Not everybody realizes that the indices that we refer to as “passive” are actively-managed. Case in point: the S&P 500 index.
Over the last three years, four dozen companies were removed and replaced in the index, and this made a difference in its performance. An equal-weight basket of the companies that were removed from the S&P 500 is down 47% this year, almost five times more than the index’s 2020 decline so far. Just five of the ousted firms have posted positive returns, while oil and gas companies like Chesapeake Energy Corp. and Transocean Ltd. are down 80% or more.
This year, there is talk of removing 30 companies, which would rank among the busiest years for the team that decides which firms to include and which companies to drop. The S&P analysts are looking at how the COVID-19 epidemic is affecting various publicly-traded corporations—like Capri Holdings Ltd., owner of Versace and Jimmy Choo, which was dropped from the S&P 500 down to the S&P Small Cap Index after it lost $5 billion in market valuation this year. Travel and leisure firms are said to be candidates for the next round of exclusion. Meanwhile, two companies that posted double digit gains during the pandemic—medical device company DexCom Inc. and Domino’s Pizza—have been added to the large cap index this year.
Most indexes and index funds—including the S&P 500—are weighted according to market capitalization, which means that companies that are added or dropped at the bottom of the list impact the index’s overall return far less than the mega companies like Microsoft, Apple, Facebook, Google and Amazon. This presents another puzzling anomaly: the performance of the index—which many people think of as a proxy for the economy—is increasingly unrepresentative of the damage that is being done to the rank and file companies all over the country. The unusually high turnover in the S&P 500 tells us that there is more disruption going on than the return numbers are telling us.