The S&P 500 index is a system for quantifying and picking approximately 500 stocks that are updated regularly. The S&P 500 is weighted by market cap and stocks enter and leave their index based primarily on their size. Companies that do well and grow in market capitalization enter the S&P 500 and the companies that drop in size fall out of the index. The biggest and most successful companies in the world that are in a price uptrend get the most weighting in the S&P 500 while the weighting drops for the less successful companies that have prices in downtrends.
The S&P 500 index system is designed to let winners run and drop losers out of its holdings. This is a type of trend following system due to the way it is built and maintained. The S&P 500 index also has a survivor bias built in. The companies that are going bankrupt leave the index early as their price drops out of the market cap threshold and the new growing companies enter the index early when they grow to a certain market cap size.
The S&P 500 is not stagnant as it is letting its winners run and cutting its losers short. The S&P 500 index is managed as a rule based system and that in itself is an edge over active money managers that can make emotional, opinionated, and ego driven decisions at times leading to making bad choices and incorrect timing in their holdings.
The committee that selects the components are free from the pressure of quarterly returns and performance pressures so can choose the S&P 500 components in a more academic rule based way than mutual fund managers can choose their funds holdings. This is an edge as it removes the filters of emotions, ego, and stress that lead to so many mistakes in the investing world. The S&P 500 index and the mutual funds and exchange traded funds that track it regularly outperform actively managed mutual funds and hedge funds.
Indexes are adaptive and designed to reflect the American economy. They are also diversified across all the different sectors.
“When considering the eligibility of a new addition to the S&P 500 index, the committee assesses the company’s merit using eight primary criteria: market capitalization, liquidity, domicile, public float, sector classification, financial viability, length of time publicly traded and listing exchange.”
“The committee selects the companies in the S&P 500 so they are representative of the industries in the United States economy. In order to be added to the index, a company must satisfy these liquidity-based size requirements.”
- Market capitalization is greater than or equal to US$5.3 billion
- Annual dollar value traded to float-adjusted market capitalization is greater than 1.0
- Minimum monthly trading volume of 250,000 shares in each of the six months leading up to the evaluation date.
– Wikipedia
The S&P 500 index is dynamic and evolves with the economy and advancing technology as it reflects the current market environment. It does not rely on the skill of a money manager it follows the biggest trends of the times reflected in the companies market capitalization and fundamental success in growing sales, revenue, and profits in the long term.