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.








closet indexing

“Closet indexing” is the term used to describe the practice of portfolio managers who claim to be active managers–and charge correspondingly high fees–yet maintain holdings that replicate the structure of their benchmark indices extremely closely.

What’s wrong with this?

On the one hand, the empirical evidence is that the average active portfolio manager in the US consistently falls below the performance of his benchmark index, so indexing–even closet indexing–is a viable strategy for beating most of one’s competitors.

On the other, the justification the much higher fees active managers charge is to compensate for maintaining a research department of investment professionals and for skill in figuring out a portfolio structure that both differs from the index and provides superior performance.

The issue, then, is that the closet indexer offers the client a low-cost index product in a very expensive package.  This is socially acceptable, even desired, in some circumstances–like when a luxury car dealer charges $200 for an oil change that goes for $35 at the neighborhood Jiffy Lube.

I have some sympathy for closet indexing, although not a lot.  Unlike the luxury car dealership, where by paying six times the going rate for services the customer makes a status-building public display of having money to burn, investors of all stripes have a severe aversion to underperformance.  As one of my old bosses was fond of putting it, “The pain of undereperformance lasts long after the glow of outperformance has faded.”  Outperforming is also hard to do.  So I can see how an “active” manager can drift toward the index as a strategy.

Still, to justify collecting active management fees, one should at least make an effort.


More tomorrow.