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While the active vs. indexing argument rages on in the investing world, it is a moot point. Everything is actively managed. The only difference is that some funds are more actively managed than others. (Sorry Bogle.)
Every single index out there was created by someone or by some committee and it is regularly updated and managed to keep pace with the changes in the real world.
That goes for the Standard & Poor’s 500 Index, the behemoth out there that has more money following it than any other index out there. The composition of the list of 500 stocks is presided over by the S&P Index Committee, a group of employees of McGraw-Hill Companies.
They follow a few guidelines:
- U.S. Company
- Market Capitalization: min. $4 billion
- Public Float at least 50%
- Adequate Liquidity and Reasonable Price.
- Sector Representation
- Company Type: operating, not CEF, REIT or BDC
But, in the end, these are just guidelines and the committee has full discretion to include any company and to exclude another, even if it technically meets all the criteria.
Every once in a while the committee faces a rare situation where a large portion of the S&P 500 Index does not meet one or more requirement they have outlined. Usually the simply ignore it and hope that it just goes away on its own.
In October 1987 there were 35 S&P 500 Index stocks that traded for less than $10 a share. In the aftermath of the September 11th terrorist attack, 59 S&P 500 Index companies traded for less than $10 a share. Right now we are going through a similar situation.
Currently there are about 101 S&P 500 Index stocks trading at sub $10 a share. Unbelievably, one S&P 500 component, E*Trade (ETFC), closed below $1 a share. And there are 36 stocks trading below $5 a share. These are levels at which stocks are called “penny stocks”. You can find a table of the constituents, ordered by share price here:
This isn’t just embarrassing for the companies and the index committee. More importantly, it presents a real problem for mutual fund managers who are restrained by covenants from buying shares trading at less than $10 or a low capitalization level. Although somewhat arbitrary, these restrictions are there to define a mandate for the manager and to protect the fund’s investors from “penny stocks” which are seen as more risky.
What is happening now is that many funds simply can not buy more shares of certain companies, even if the manager feels it is a good idea to do so for the investors. Usually they can keep the shares already in the fund but thanks to the covenant, the market can not look forward to demand coming in to prop up these shares. At least not from the usual domestic fund market.
Also, 186 S&P 500 Index stocks have less than $4 billion market capitalization. With 25 companies failing to even meet the $1 billion capitalization level. This creates problems when mutual fund managers are bound by covenants to only purchase large capitalization stocks. The only bright side is that a few medium and small capitalization mutual funds can now buy former stalwarts of Wall Street.
There is no question that we are going some truly extraordinary times right now. Almost every single measure or method to look at the stock market is off the charts. The market unequivocally broke through support today. Even slicing through Weinstein’s support level. The only consolation that longs can take home is that this is an unprecedented market environment, dwarfing previous bear markets in intensity and in its uniqueness.
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