[tristanj]

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.

[pdpi]

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.

[tristanj]

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.

[f33d5173]

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.

[tristanj]

> it excludes one or two stocks.

It's more than that. None of SpaceX, OpenAI, nor Anthropic will meet the criteria, and they will make up a significant part of the US stock market. Each of these companies is heavily investing their cashflow into growing the company and are unlikely to be profitable many years.

The inclusion criteria prioritizes companies that extract their cashflow into profit, and excludes companies that invest their cashflow into growing the company. For example, when Jeff Bezos ran Amazon he described his company as "famously unprofitable, And that is a conscious strategy and an investment decision." Amazon only joined the index in 2005, nearly 8 years after IPO, even though it was a significant member of the stock market at the time.

[tankenmate]

"The inclusion criteria prioritizes companies that extract their cashflow into profit", in almost all cases, yes. But if you want to buy into these newer stocks there are various high growth indices you can buy, no one is stopping you. If you want to buy into only one or two of those stocks then you can. It's a free market for stocks and it's a free market for indices. There's no regulation that says the S&P has to include certain stocks.

[tristanj]

The issue is a contradiction with what S&P 500 claims to do vs what they actually do. S&P 500 claims to be the "best single gauge of U.S. large-cap equities". But if they exclude high-growth no-profit large-cap equities such as (Anthropic, OpenAI, SpaceX) from their index, then S&P is doing a poor job at what they claim to benchmark.

It's not not an insignificant oversight. The valuations of (Anthropic, OpenAI, SpaceX) total to ~5% of the total US stock market.

[ab5tract]

And that approach famously hurt investors, the economy, and/or Amazon in what specific ways, exactly?

[tristanj]

It meant that during this time, the S&P 500 index less accurately tracked the large-cap U.S. market.

[yoavm]

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.

[tristanj]

The S&P 500 is primarily a benchmark index, not a list of approved stocks to invest your 401k into. The GP is conflating the two. GP is claiming there's a subset of stocks that people don't want to invest in, and these should not be included in the S&P 500. Sure. But, per the S&P website, the S&P500 was created as a benchmark of U.S. large-cap equities. On their website, S&P advertises it as "the best single gauge of large-cap U.S. equities".

The S&P 500 index was created in 1957. It was created decades before the first index fund (by Vanguard), which copied the index in 1976.

The index is intended to follow the all of the largest large-cap U.S. equities, not pick and choose which ones to invest in. GP is arguing that many passive investors, who blindly follow the S&P500 index, don't want to invest in these upcoming unprofitable mega-caps. That's not how the index investing works, that's picking and choosing approved sectors of the market, which is active investing. If you want active investing, buy an active investing product, don't buy a fund that copies the benchmark index.

[Starman_Jones]

> The index is intended to follow the all of the largest large-cap U.S. equities, not pick and choose which ones to invest in.

This particular piece is incorrect. S&P has preexisting rules to pick and choose which large-cap equities to follow. They had a discussion about whether to drop those rules in order to become a more accurate benchmark, and they chose to stick with what they had been doing.

Regardless of what they say they were doing (or what they’re trying to do), the fact that they changed nothing means that what they had been doing is the same as what they are doing now, ie, picking and choosing stocks at the risk of diminishing their benchmark capabilities.

[ywvcbk]

> 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.

[rurp]

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...

[yfg2]

Why do index inclusion rules exist in the first place….?

Go do a google search

[Nykon]

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.