S&P’s own Santa Claus

This essay appeared in Citywire Selector on December 22, 2015. 

Santa

 

“He’s making a list,

And checking it twice;

Gonna find out who’s naughty or nice.

Santa Claus is coming to town”

 

 

Recognize these two distinguished and powerful gentlemen?

In addition to their similar choices in eyewear and beards, they share some further remarkable attributes:

  1. They (and their respective staff of elves/market professionals) both work in utter secrecy.
  2. The products of their efforts are widely known, referenced, and used around the world to monitor, gauge, and punish or reward behavior.
  3. They both have a huge impact on the U.S. economy and equity markets.
  4. A suspended disbelief permeates the minds of the boys & girls / investors on whose faith their power relies.
  5. Their methods of work are complex and opaque. Yet, they are assumed to be simple and transparent.
  6. Media and commercial promotion are central to their success and, in turn, their success is central to that of various media and commercial concerns.
  7. Both impose guidelines for being naughty and nice. Both keep detailed lists. Being on or off those lists is a big deal.

_____

 

Okay, we all know Santa, but who is the gentleman in the bow tie? He is none other than Dr. David Blitzer – the single most influential investment manager that you are likely not keeping close tabs on – but should be.

Dr. Blitzer is the Managing Director and Chairman of the Index Committee at S&P Dow Jones Indices. He has held the reins of the S&P 500 sleigh since 1995. He has guided the Index through the ups and downs of the last twenty years. An estimated $2 trillion of investment product is managed using the Index while trillions more are benchmarked against it. Beyond the S&P 500, Dr. Blitzer is the Chairman sitting atop all of the investment committees governing the tens of thousands of indices of the S&P/Dow Jones enterprise. He is a very powerful man indeed.

 

An Active Committee Secret Workshop

While Dr. Blitzer is the public face of the S&P 500 committee, the identities of the dozen or so committee members that work closely with him on the management of the S&P 500 are not disclosed to the public. Their collective work (if you can forgive my analogy) of making lists and putting candy canes and coal in stockings hung with care, is done with a bit of S&P magic. Of course, true believers don’t ask too many questions.

But if a key element of ‘index’ investing is transparency, this unnamed committee of helpers presents investors with a conflict. Shouldn’t investors know who is making the decisions to include or exclude companies from the largest aggregator of equity investments in the world? Imagine the outcry of investors if suddenly all active investment strategies managed by committees were not published. The shouts of ‘black box’ would be deafening. Sophisticated investors would not stand for it.

Now if the S&P 500 was fully systematic and ‘rules-based’ and its committee was not using its own judgment to create the naughty and nice lists (of which companies are in or out of the index), anonymity would be a minor concern. But this is not the case. There is a considerable amount of active decision-making involved. In an article published in 2014, Dr. Blitzer discusses the special circumstances of the S&P 500 and its “active committee.”

“The S&P 500 is maintained by a committee of market professionals… [u]nlike many other S&P Dow Jones Indices and the majority of indices offered by other index providers, there are no rigid or absolute rules for the S&P 500; the Index Committee have some discretion in selecting stocks or responding to market events.”[1]

Market professionals using ‘discretion in selecting stocks or responding to market events’ is a precise description of what we believe active managers do. The S&P 500 is, of course in its own special way, actively managed. As such, investors should demand the same level of transparency that they do from other actively managed strategies – at the very least to be informed about who is making the decisions.

 

A Jolly Myth

Ever wonder why Santa does it? All the toy making and travel – it has got to be stressful. Simply to see the joy on the faces of children? Or perhaps as a service to parents for keeping their kids in line for the two week run-up to the big day in exchange for half a glass of milk and some cookies? In his modern form, he is a creation of the Coca-Cola Company used (very effectively) for raising the consuming spirit around Christmas time. Not to spoil the holiday spirit but indices are massive money-making machines – hundreds of millions of dollars of revenue are made from the broad suite of indices offered by the S&P Dow Jones Indices through the licensing of their brands to ETFs, funds, and other products.

Though mythology often purports the S&P 500 as an agnostic, rule-driven neutral tool of measurement, its promotion and uses demonstrate otherwise. This entity holds the S&P 500, Dow Jones Industrial Average and thousands of other indices. It is a joint venture of majority owner McGraw Hill Financial along with CME Group and News Corp. Commercial considerations, not pure academic rigor, motivate their activities.

 

True Believers

The S&P 500 is the best-known, most impactful and universally accepted metric of the US market. It is axiomatic. Market participants have treated the S&P 500 with a level of respect and infallibility that is unwarranted. Active decisions to include and exclude companies are driven by people. Because of this, behavioral biases, key man risk and subjective errors are inherent to the process.

Dr. Blitzer is undoubtedly smart and highly experienced. He wields tremendous influence over investor decisions. But unlike Santa, he is also mortal. Who will take the reins when he is no longer able to command the Committee? Because of his importance and the active nature of the methodology in selecting stocks, it would behoove investors to find out.

How will the Index change under new leadership and what are the particular contributions of the individuals on the committee? Is there a Rudolph amongst the Committee with a particularly strong influence and tools of prescience? These are important questions to which investors accept receiving no answers. They just believe.

 

Suffering with Active Management

In the ever-present active/passive debate, Dr. Blitzer is no neutral judge – he is a fully-fledged index-investing advocate. If there is any doubt about the affinities of Dr. Blitzer, take into consideration his gratitude and words of admiration towards the supporters of his work:

“…[T]here are three people who I have been fortunate to meet who deserve a lot of credit for the growth of indices and index investing: Jack Bogle, who founded Vanguard and put index investing within everyone’s reach with the Vanguard S&P 500 fund (ticker: VFINX); Burt Malkiel of Princeton University, who explained why indices are the right way to invest in his book, A Random Walk Down Wall Street; and Nate Most, who invented ETFs. Without these three, we would all still be suffering with active management.”[1]

For investors still willing to ‘suffer’ with active management, your time may soon arrive. Certainly the S&P has proven to be a formidable opponent and for good reason – its power to grasp the minds and wallets of investors through low fees and easy access to the US equity markets is very real. This is indeed a valuable service and has helped to reshape the investment landscape for the good. But competition is emerging – this is also good.

Re-invigorated ‘active-light’ strategies incorporating factor-based approaches are providing new options to index-oriented investors. At the further end of the spectrum, the degrees of investment freedom for active managers are broadening. All of this is leading to the potential of a very real advantage for active management just when it may be needed most.

Manager due diligence, particularly during periods of market transition, is vital. Investors allocating money across the shifting passive/active investment spectrum should be aware of how the naughty/nice lists are made and by whom. This should be true for all list makers everywhere.  “He knows if you’ve been bad or good. So be good for goodness sake!”

 

[1] Extracted from an article/blog written by Dr. David Blitzer entitled “Inside the S&P 500: An Active Committee”  http://www.indexologyblog.com/2014/08/07/inside-the-sp-500-an-active-committee/