The S&P 500 Composite Stock Price Index is a market-value-weighted index (shares outstanding multiplied by stock price) of 500 stocks that are traded on the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), and the Nasdaq National Market System (NASDAQ). The weightings make each company’s influence on the Index’s performance directly proportional to that company’s market value. It is this characteristic that has made the S&P 500 Index the investment industry’s standard for measuring the performance of actual portfolios.

Unlike other lists of companies, the ones selected for the S&P 500 are not chosen because they are the largest companies in terms of market value, sales, or profits. Rather, the companies chosen for inclusion in the Index tend to be the leading companies in leading industries within the U.S. economy. That is why in 1968 the Index became a component of the U.S. Department of Commerce’s Index of Leading Economic Indicators. Now published by the Conference Board as the Composite Index of Leading Indicators, that widely followed index is used to signal potential turning points in the U.S. economy.

S&P 500 Index History

The origins of the S&P 500 Index go back to 1923, when Standard & Poor’s introduced a series of indexes that included 233 companies that were grouped into 26 industries. Since then, Standard & Poor’s has expanded its coverage over the years; in July 1996, following introduction of a new, comprehensive industry group classification system for all securities in the S&P Stock Guide Database, there were 105 specific industry groups in 11 economic sectors represented in the S&P 500. Four major industry sectors have also been developed: Industrials, Utilities, Financials, and Transportation. The number of companies in each major industry sector has been allowed to float since 1988 in order to enable the Standard & Poor’s Index Committee to react efficiently to an increasingly dynamic economy and stock market.

“Over the years, the S&P 500 has really become the index to beat for most investors,” according to Roger Fenningdorf, director of U.S. equity research at the Rogers Casey pension-fund consulting firm. “In the world of professional money management, we’ve all become fixated on how well managers do relative to the S&P.”

The use of the S&P 500 as the proxy for the overall stock market predates the widespread adoption of the Capital Asset Pricing Model (CAPM) in the 1970s. As the amount of money invested in the equity markets grew in the 1950s and 1960s, the need for a capitalization-weighted, broad-based market indicator that reflected how people actually invest in equities became self-evident. By convention, the S&P 500 Index, already well-known to academics and to professional money managers, was used as the market portfolio in tests of the CAPM. Betas of individual stocks were then calculated against the S&P 500 Index, which by definition had a portfolio beta of 1.00.

These days, it is difficult to find an equity manager who cannot tell you how its portfolio’s performance compares with the S&P 500. Some companies, such as Fidelity, even make a portion of their management fees contingent on whether their funds outperform the S&P 500. In the Magellan Fund’s case, its fee is raised or lowered by 0.20% of assets, depending upon how it fares against the S&P 500’s total return over a rolling three-year period.

However, it is no longer possible for an investment management firm simply to claim that it beat the S&P 500. The adoption of performance presentation standards by the Association for Investment Management and Research (AIMR) and their inclusion as of January 1, 1993, as Standard III F of the AIMR Standards of Professional Conduct, has focused attention on the need for properly defined and utilized investment benchmarks. The firm must use a benchmark that parallels the risk or investment style the client’s portfolio is expected to track.

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