the structure of the S&P 500, and why it matters…

…to us as individual investors, for the portion of our assets we choose to manage actively.

As of the close of trade in New York last Friday, the Standard and Poors 500 was weighted, by sector, as follows:

IT      24.0%

Financials      14.8%

Healthcare      14.1%

Consumer discretionary     12.1%

Industrials     10.1%

Staples      8.1%

Energy      5.8%

Utilities         3.1%

Materials     3.0%

Real estate     2.9%

Telecom      2.0%.

The goal of active managers is to have better results than the index (I could say “an index fund,” but the two are the same, less the small fees an index fund purveyor charges).  We’ll only have different results if we have different holdings than the S&P.  And if our holdings aren’t different–either different names or different weightings (or both)–we can’t be better.  In order to be different our first job is to know what the index looks like.  The list above is a first cut.

Let’s rearrange it to show the sectors in order from the most sensitive to general economic activity to the least.  I’m going to divide the sectors into three groups, from those that do best in a red-hot world economy, those that will still do well with so-so growth, and those that have the most defensive characteristics–meaning they do their best relative to the index when economies are contracting.


most economically sensitive

Materials      3.0%

Industrials      10.1%

Energy     5.8%

————————————-total = 18.9%

economically sensitive

IT      24%

Consumer discretionary     12.1%

Financials      14.1%

Real estate         2.9%

————————————-total = 53.1%


Healthcare     14.1%

Staples     8.1%

Telecom      2.0%

Utilities     3.1%

————————————-total = 27.3%.

I’ve stuck Energy in the most sensitive segment.  Recently it’s been marching to its own drummer, as the big integrated oils restructure and as the crude oil price yo-yos up and down.  Ultimately, though, I think in today’s world oil is just another industrial commodity that’s not that different from steel or aluminum.  Put it somewhere else if you disagree.

This isn’t the only reordering we could make.  We could also arrange the index by market capitalization in order to either emphasize big stocks or small ones in our holdings.  But this is the most common one professionals, and their institutional customers, use.  Personally, I think it’s also the most useful way to think about the index.


To my mind, the most striking thing about the S&P 500 is that it is mostly geared to a rising economy.  If we think recession is brewing, tiny changes in holdings aren’t going to make much of a difference in relative performance.

Another–very important–point is that if you have a portfolio that’s, say, 10% Healthcare, and your benchmark is the S&P 500, you’re betting against Healthcare as a sector, not on it.








index fund gains in the US

According to a survey reported in the Financial Times and done at the newspaper’s request by Morningstar, assets in US index mutual funds now comprise a third of total domestic mutual fund assets.  That’s up from 25% this time three years ago.

Nevertheless, actively managed assets under management have risen by 14%, despite the market share shift.  So the fees being collected by active managers are up.  This is doubtless due mostly to the fact that markets have been rising.  The S&P 500 is up by about a third over the three-year span, the Bloomberg Treasury index by 12%.  Watch out, though, if markets flatten or begin to decline.


More bad news:  the FT is reporting that 90.2% of US active equity managers underperformed their benchmark, after deducting fees, over the twelve months ending June.  Not numbers that will stem outflows.


Since I’m getting such an unbelievably late start today, I’ll only make two points:

–in the investment organizations I’m aware of, management control is in the hands of professional marketers, not professional investors.  I think their giving a much higher priority to selling rather than making products is a substantial part of the underperformance problem for these firms.  It’s highly unlikely, I think, that marketers will volunteer to step down and turn the reins over to makers.  So I expect underperformance issues will continue.  If I’m correct, the next bear market could prove crushing for these organizations, since the combination of falling prices and client withdrawals will doubtless mean sharp declines in profits.  Where will the money come from to beef up research and portfolio management operations then?

–some large investment management firms known for active management are reported to be finally entering the index fund market themselves.  First of all, this seems to me to show the marketing bent of their managements, giving support to my first point.

In addition, index funds have very large economy of scale effects and the oldest/largest have been in existence for decades.  Because of this, I can’t imagine that Johnny-come-lately firms will ever have profitable index offerings.  The firms may subsidize their index funds  so that the fees for you and me will be on a par with bigger rivals’, but I don’t see how the subsidies can ever be taken away.  Yes, such firms may retain assets, but their bottom lines will be worse off than if they retained them.

Hope over experience?—S&P Indexology

I subscribe to the S&P Indexology blog.  It’s written by S&P staff involved in manufacturing the company’s well-known financial markets indices.  Usually it’s interesting, although the writers’ true-believer conviction that no active manager is capable of matching–to say nothing of outperforming–his benchmark index often shines through.

Yesterday’s post, titled “Hope over Experience, ” is a case in point.  It takes on a recent, pretty silly Wall Street Journal article that muses about an “Old-School Comeback”  of active stock mutual fund management, based on recent outperformance of the average active manager over the S&P 500.  “Recent” in this case means the first four months of 2015; “outperformance” means a gain of .33% versus the S&P.

The obvious observations are that the time period cited is extremely short and that the gain versus the index is probably statistically insignificant.  S&P Indexology goes on to say that the comparison itself is bogus. The S&P 500 is neither the appropriate or the actual official benchmark for many stock mutual funds, which have, say, growth, value, small-cap or other mandates and other benchmarks than the S&P 500.

So far, so good.

Then come two comments straight out of the university professor’s playbook:

–The first is the argument that because an active manager’s portfolio structure may be dissected, after the fact, into allocations that could have been replicated by indices, actually creating and implementing that structure in advance has no value.  That I don’t get at all.

–Indexology concludes by suggesting that because investing in the aggregate is a zero-sum game–the total winner’s pluses and losers’ minuses exactly offset one another, before costs–there can’t be any individual investors who consistently outperform.

I believe that life in general, and investing in particular, is a lot like baseball.  (I’ve been thinking about baseball recently because it’s in season).  The second Indexology comment is much like saying that the Giants’ winning three World Series in five years is a random occurrence.   …or that the change in ownership of the Cubs and the hiring of Theo Epstein have nothing to do with the club’s success this year.  Yes, bad teams get a preference in the draft each year, but the end to a century of futility?

…and what about the Braves and Cardinals, who consistently field above-average teams even though their draft positioning does them no favors.

To be clear, I’m an advocate of index funds.  My reasoning for this is not that outperformance is impossible (the ivory tower orthodoxy) but that it takes more time and effort than most people like you and me are willing to put in to locate and monitor active managers.  I’d be much more comfortable with Indexology saying this.

why more equity managers don’t outperform

1.  Most US equity managers, prompted by personal inclination and the wishes of their employers and their institutional clients, adopt either a value (buying undervalued assets) or a growth(buying accelerating profit growth) investment style.  In a typical business cycle, the first two years favor value stocks, the latter two growth issues.  Over that cycle, a manager is likely to have two good years, one so-so year and one bad year.  A skilled manager, however, will outperform over the cycle sc s whole, no matter what his style is.

This is another way of saying that the criterion of outperforming every year is unreasonable.

2.  a truism:  the pain of underperformance lasts long after the glow of outperformance has faded.  A manager who builds a riskier portfolio expecting fame and fortune from significant outperformance risks exploding on liftoff and outperforming badly–thereby losing both his clients and his job. He also gives his firm a significant black eye. No one, however, gets fired for underperforming slightly and being in the middle of the pack of competitors.

As a result, many long-lived investment organizations are constructed on the idea of strong marketing and so-so performance.  I’ve always regarded Merrill as the poster child of this approach in the mutual fund arena.

In other words, outperformance isn’t the most important attribute of a successful investment product.

3.  Most investment organizations find that a running a research department of their own is difficult and expensive.  Many, especially (in my view) the majority which are run by professional marketers, have long since eliminated proprietary research and have been depending heavily on brokerage houses to supply this service.   Doing so has the additional advantage that in-house analysts are no longer a drain on management fees received (brokerage house research is paid for with clients’ commissions).  That “solved” a problem and enhanced profits at the same time.

However, brokerage houses gutted their research departments during the market downturn in 2008-09.  The sharp decline has also accelerated an ongoing trend away from traditional investment managers and toward a diy approach using index funds.

So there’s no longer a plethora of high-quality brokerage reports and no “extra” management fee money to reconstitute proprietary research departments. Where are the good new ideas going to come from?  I think this new client preference for investment performance over salesmanship will create severe difficulties for traditional investment organizations.


the Mainstay Marketfield fund

I was reading in the Financial Times over the weekend about the Mainstay Marketfield mutual fund.  It gathered the most money of any mutual fund in the US during 2013, $13 billion, but it is now apparently suffering sharp redemptions after very badly underperforming in 2014.

Mainstay Marketfield

Mainstay Marketfield is the leader among “liquid alternative” funds, which purport to provide the hedge fund experience to ordinary investors like you and me through a mutual fund.  Why exactly that’s a good thing is another issue, since hedge funds as a class appear to underperform an S&P index fund on a regular basis (on top of this, the information the public has about them comes from their voluntary self-reporting, whose accuracy academic research has shown to be suspect).

Anyway, on the idea that one can learn a lot by examining things that go wrong, I thought I’d take a look at Marketfield.

Here’s what I found by spending a couple of hours looking at the fund’s SEC filings, the managers’ backgrounds, the Mainstay fund family site and charts of the fund’s performance.  The picture may not be complete, but it’s what I think a careful observer would come away with:

–the lead manager has worked in finance, mostly as a strategist, for 34 years.  His colleague has 21 years in the business.  As far as I can see, neither had any training/experience/supervision in portfolio management before they opened the Marketfield fund in 2007.

–the fund opened to the public in March 2008.  It had a period of strong outperformance vs. the S&P 500 during the stock market decline of late 2008-early 2009, when its losses were only about half those of the market.  From the bottom in March through mid-2013 it matched very closely the performance of the S&P 500.

–in 2012, Marketfield sold itself to the Mainstay fund family of New York Life.  NYL retained the Marketfield managers as subadvisors–meaning the two continued to run the fund.  Sales of fund shares skyrocketed once Marketfield hitched itself to the NYL salesforce.

–in late summer 2013, the fund began to underperform the S&P fairly steadily.  From the beginning of September 2013 though last Friday, the A shares were down by 8.9% vs. a gain by the S&P of 25.6%.  Factor in a 5.5% sales charge holders paid to obtain shares and the results are that much worse.

What happened?

The managers appear to me to be envisioning a world of runaway inflation of the type that beset the US in the late 1970s.  In such an environment, it would be important to own shares of companies that could raise prices at an inflation-beating rate and to avoid those that could not.  In the Seventies, the “bad” sectors were Healthcare, Utilities, Staples and Consumer Discretionary.  The “good”: ones were those that held  hard physical assets, like industrial plant and equipment, real estate or mineral resources.

In the 1970s, financials were losers;  they issued mostly fixed-rate loans, and they were constrained by government regulations that capped the interest rate they could pay for deposits.  In today’s world, those restrictions are gone; loans are typically floating-rate; and the banks can be involved in brokerage/investment banking.  So, arguably, financials would be winners if inflation were to accelerate strongly.

Whether this was their thinking or not, this description fits the portfolio they created.

my look at the portfolio

on the long side

The Marketfield portfolio held/holds Financials, Industrials and Materials.

It has no Healthcare, little IT, no Staples, no Utilities (all of which have been the stars of 2014).  It also has little Consumer Discretionary and almost no Energy, both of which have been good things.

on the short side

The fund shorted Utilities, Staples, and Retail.  It also appears to have winning bets against the euro and the yen, the latter offset by significant holdings in Japanese stocks.

What I find striking is that while the market has been going against Marketfield for over a year, the portfolio strategy I see is basically unchanged.

more going on

There’s also more going on than I’ve been able to see.  Everything I’ve said until now would lead me to believe that the fund’s year-to-date return should be around zero  not -12+%.  The long US stocks should be up 5% -10% (the only sector in negative territory is Energy).  I’m figuring that shorting industries that are, say, +20%, wipes out those gains, but does little more damage because the shorts are a lot smaller than the longs.

So something else is happening.  I don’t know what.  Broadly speaking, the reasons may be staring me in the face in the quarterly SEC filings I’ve seen (the stock selection looks uninspired, and maybe a little weird–of the holdings, I own only INTC and SPLK–but it’s almost impossible to lose 12 percentage points through bad stockpicking, particularly with the large number os stocks the fund holds).  Or there could be transactions that are opened and closed within the quarter and therefore don’t appear in the quarter-end statements.

my take

Th Mainstay site contains a Barron’s reprint from October in which the author touts Mainstay Marketfield as having double the returns of similar long-short funds since the market bottom in 2009.  Hard to believe that other long-short funds have lagged so far behind the S&P.

I find the $5 billion in redemptions (about 30% of peak assets) the FT says Marketfield has had ito be a stunningly large amount for a load fund.  My experience is that even in deep bear markets load funds have redemptions of maybe 10%.  This implies to me that neither the financial advisers who recommended the fund nor the clients who purchased it really understood what they were buying.

What I find most odd is that NY Life, which presumably has an older and more risk-averse clientele, should have chosen Marketfield to offer to its customers.  What’s odder still is that the move was spectacularly successful as a marketing move–until the wheels came off the performance.

It will be interesting to see if Marketfield can stage a comeback.  If the FT is right about the extent of redemptions (I presume it is; I just don’t know), the first indication will be whether the managers use the selling they have to do to reshape the portfolio.  Standard procedure would be to take some of the edge off the losing bets.  To my mind, “staying the course” would be the worst thing to do (personally, I think the runaway inflation idea is just wrong).  We’ll see when the next SEC filings come out next month.





a professional portfolio manager performance check

I subscribe to the S&P Indexology blog.  Like most S&P communications efforts, I find this blog interesting, useful and reliable.

Anyway, two days ago Indexology published a check on the performance of equity managers who offer products to US customers.

In one respect, the findings were unsurprising.  For managers with US stock portfolio mandates, well over half underperformed their benchmarks over the one-year period ending in June.  Over five years, more than three-quarters failed to match or exceed the return of their index.

This is business as usual.  Why this is so isn’t 100% clear to me.

One of my mentors used to say that ” the pain of underperformance lasts long after the glow of outperformance has faded.”   I think that’s right.  In other words, clients will punish a PM severely for underperformance, but reward him/her by a much smaller amount for outperformance.  In a world where risks and rewards aren’t symmetrical, it’s probably better not to take the buck-the-crowd positions necessary to outperform.  Instead, it’s better to accept mild underperformance, keep close to the pack of rival managers and spend a lot of time marketing your like-me/trust-me attributes.

(To be clear, this isn’t a strategy I wholeheartedly embraced.  I generally achieved significant outperformance in up markets, endeavored not to lose my shirt in down markets.  My long-term US results were a lot better than the index, but at the cost of short-term volatility that was greater than the market’s.  Pension consultants, heavily reliant on academic theories of finance, tended to demand a smoother ride, even if that meant consistently less money in the pockets of their clients.  Yes, a constant problem for me.  But it illustrates the systematic pressure put on managers to conform, to look like everyone else.)


The surprising news in the blog post comes in international markets.   Generally speaking, the markets overseas are simpler in structure, information flows much more slowly than in the US, and PMs tend to be ill-trained and poorly paid.  Rather than being the culmination of a long a successful career, being a PM abroad is often only an early stepstone to something better.  So pencil in outperformance.

On a one-year view, however, Indexology reports that the vast majority of managers of global, international and emerging markets portfolios all underperformed their benchmarks.  This is the first time this has happened since S&P has been checking!!

I don’t watch this arena closely enough to have a worthwhile opinion on how this happened.  The fact of underperformance itself is surprising–the fact that more than 75% of managers of international funds underperformed is stunning.  My guess is that no one saw the deceleration of Continential European economies coming.

For anyone with international equity exposure, which is probably just about everyone, current manager performance is well worth monitoring closely.