Comment by tristanj
17 hours ago
At a fundamental level, an index is supposed to reflect the market. If the current market is IPO-ing unprofitable companies at absurd multipliers, the index should reflect that. Because that is the market.
The longer major indexes exclude these companies, the further the index strays from representing the market, and the worse they do their core job of tracking it.
It's not the index's fault that market is pushing out overpriced and unprofitable companies.
Indices are supposed to reflect a part of the market. That's why you have all of S&P500, the Dow, NYSE Composite, and Nasdaq Composite (and several others) in the US — They each reflect different attributes of the market as a whole.
As it stands, it's clear that the users of S&P500 are not interested in the performance of the parts of the market made up of overpriced (and potentially highly volatile) IPOs.
The problem with your framing of "users of S&P500 are not interested overpriced IPOs" is that it conflates two fundamentally different things: what an index describes vs what investors prefer. The moment you start filtering out parts of the market based on investor appetite vs market reality, you stop building an index and instead start creating an actively managed product. That's active investing. It's no longer an index.
The S&P 500 is used as the benchmark of the market by practically everyone. Journalists, policymakers, investment managers, politicians, regular investors, everyone I know. If the benchmark that everyone uses as a market proxy is systematically excluding a substantial part of the market, then the gap betweeen "the index" and "the market" has real consequences.
You can't have it both ways: Either the S&P 500 is a market proxy, in which excluding parts of the market is a problem; or it's a curated slice, in which everyone needs to stop it as the default benchmarket for the market.
An index is an index. It works fine as an index if it excludes one or two stocks. People seem to forget as well that this is a question of waiting a single year before it including the stock. It is literally just long enough to make sure the price settles, it's not some catastrophic thing.
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It doesn't conflate anything. The inclusion rules weren't given to us by God, they were created by humans because they thought, rightfully, that people will be interested in that as a product ("prefer"). As the market changes, the product can be adjusted.
Lastly, there's no such a thing as a real "market proxy", except the whole market. If you scope any subset of it, you're making some inclusion and exclusion rules.
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> what an index describes vs what investors prefer
What makes you think S&P 500 did not become the most popular index (instead of full market ones) because of the rigid entry criteria and and rules for weights.
Amongst other things the weighting is not even based on the market cap.
No, an index reflects a specifically defined subset of the market. The S&P 500 is very much not trying to include the entire stock market. There are more than 500 public companies...
Why do index inclusion rules exist in the first place….?
Go do a google search
I feel like a lot of people discussing here have no clue what they're talking about, they just have an opinion - which, combining both, most likely means it's an opinion they did not form themselves.
The rules for index inclusion absolutely make sense in many ways.
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