Some of you may recall the early ’80s punk rock rally cry, “Punk isn’t dead!” Given the recently announced Rage Against The Machine (RATM) tour, I would tend to agree.
We can quibble later over whether RATM falls into the same category as the Dead Kennedys, Black Flag, Suicidal Tendencies, Channel 3 and of course, The Sex Pistols (spoiler alert: IMHO, they do if only for the energy and anti-establishmentarianism), but the point here is that alpha—despite what you may have read and heard—is indeed very much alive and well.
This is not another article bemoaning the rise of passive management and raising the alarm about the impending death of alpha. If anything, the search for alpha is more alive and more accessible than ever.
Before we discuss the hows and whys behind alpha not being dead, let’s take a look at what is meant by “passive.”
From a spherical cow-land perspective, I would say the only indexes that are truly passive are those labeled as “composites” like the NYSE Composite Index, which is simply the index of everything listed on the NYSE—no sector, no market cap constraints, earnings or other factors and arguably other bias being considered for selection, no seasoning; if you’re listed, you’re in, from your IPO date until you delist.
The Russell family of indexes has an underlying methodology that is fairly agnostic as well with market capitalization, domicile and listing venue as primary drivers for inclusion. There are some eligibility rules around voting rights, but nothing that speaks directly to components’ fiscal health or viability as an ongoing concern.
Is The S&P 500 Index Active?
Let’s shift now to the $7+ trillion gorilla in the room, the Standard and Poor’s 500 Index (SPX)—the benchmark of benchmarks, the standard bearer of passive investing.
There are some broad rules around market capitalization, liquidity and surprisingly, financial viability and earnings.
Depending on your point of view, these rules are either general mechanisms to help simplify the process of focusing on relevant components, or they are conscious decisions meant to shape the constituent pool into one with desirable (as deemed by S&P) characteristics.
Either way, the effect of these rules is to create a universe of components that are ready to run the gauntlet of the next set of rules that will get us to the final list of index constituents.
Index constituent selection is covered on page 10 of the methodology. Here we go. Here’s how the SPX sausage gets made:
“Constituent selection is at the discretion of the Index Committee and is based on the eligibility criteria.”
Some may want to read that again…
How often are index components reviewed for suitability?
Does that happen on an annual or semiannual basis?
From page 26, “Changes to index composition are made on an as-needed basis. There is no scheduled reconstitution.”
So outside of some pretty wide gate rules, final component selection for SPX is completely discretionary and can occur at any time deemed appropriate by the index provider?
Isn’t this the very definition of an actively managed portfolio?
This methodology is used for the S&P 500 (SPX), the S&P Midcap 400 (MID) and the S&P Smallcap 600 (SML). I’m not saying that S&P has been deceiving us all these years. Clearly this information has been available for some time.
It does, however, set the stage for some further revelations and discussions. If SPX, MID and SML are actively managed indexes, then any derivative of them is also an actively managed index, including Select Sector Indexes.
newETFs.io respects the hard work of others and gives all credit to the remarkable folks at ETF.com. This excerpt/article was pulled from their RSS feed; click here to view the original. Please note that on occasion, the RSS feed will not have the author. When this happens this site defaults the author to "News". Make no mistake, this excerpt/article was not created by newETFs.io, it was simply shared with you.