Reinvent the Index Fund

[PushyGuyFanClub]

Since some of you folks have shown some interest in this little economic/stock market snafu we find ourselves in these days, I thought some of you might be interested in some work I've been doing on the value of the S&P 500 index fund. This, by way of background, is the most popular investment vehicle in the United States, and the Vanguard 500 fund (the most popular S&P 500 tracker) had something like $120b in assets under management before this crisis began. It's now down to about $30b, which is both withdrawals and money that went up in smoke.

My problem with the S&P 500 index fund is that -- because it weights on market cap (i.e., the size of a company) -- it was way to exposed to poorly run financial firms such as AIG, Citigroup, BofA, etc, that got big in the market by inflating their profits with extraordinarily risky loans. Thus, anyone who owned an index fund got crushed hard by this downturn...and much harder than they should have. So, I've been brainstorming ways to reinvent the index fund and it's a feature article this weekend. Enjoy, and I'll gladly take questions and/or feedback if you have it:

tinyurl.com/dk55js

[jgalt]

Mar 20, 2009 15:35:22 GMT -5 PushyGuyFanClub said:

Since some of you folks have shown some interest in this little economic/stock market snafu we find ourselves in these days, I thought some of you might be interested in some work I've been doing on the value of the S&P 500 index fund. This, by way of background, is the most popular investment vehicle in the United States, and the Vanguard 500 fund (the most popular S&P 500 tracker) had something like $120b in assets under management before this crisis began. It's now down to about $30b, which is both withdrawals and money that went up in smoke.

My problem with the S&P 500 index fund is that -- because it weights on market cap (i.e., the size of a company) -- it was way to exposed to poorly run financial firms such as AIG, Citigroup, BofA, etc, that got big in the market by inflating their profits with extraordinarily risky loans. Thus, anyone who owned an index fund got crushed hard by this downturn...and much harder than they should have. So, I've been brainstorming ways to reinvent the index fund and it's a feature article this weekend. Enjoy, and I'll gladly take questions and/or feedback if you have it:

tinyurl.com/dk55js

That was really interesting. And it does make sense from an investors perspective.

The one question i have is, when you were reporting the difference in performance between the two funds was the make up of the FQI the same 85 that it would be today or did it change based on time?

[TC]

I guess here's my questions -

Would your method have screened out AIG / Citigroup/ BofA / etc? You are making the point that the Vanguard 500 held all these companies in large amounts, and then lost a great deal on them. I'm guessing that the shareholder dilution criteria would have taken out Citigroup, but would the other ownership requirements have taken out AIG/BofA/Bear/etc pre-September?

The other question I'd have is about criteria #2 - "no poison pill" seems like a fairly subjective requirement. It seems like a reasonable one to me, but if you're trying to create the new automatic index fund, is this something that's readily available in a screen? If it's not, is it sort of within the spirit of the "smarter S&P 500"?

[PushyGuyFanClub]

The one question i have is, when you were reporting the difference in performance between the two funds was the make up of the FQI the same 85 that it would be today or did it change based on time?

The backtesting methodology was admittedly simplistic (read: flawed) because we didn't have the computational power to go back and weed out poision pills and things like that that existed in the past. What we did confirm, however, is that the FQI has very low turnover. I think something like 65 of the companies on the list would have been in it 5 years ago. What we're missing are companies that would have been in it, but then got kicked out. I did confirm (and this gets to one of TC's questions) that Citi, AIG, and the financials that wreaked havoc on the S&P 500 would not have been included at any time because of low insider ownership, lack of internal promotion, dilution over time, and most of their boards are protected from shareholder insurrection.

So, not a perfect backtest, but a preliminary backtest.

It seems like a reasonable one to me, but if you're trying to create the new automatic index fund, is this something that's readily available in a screen?

Our software here (a Capital IQ package and a Thomson package) allow us to screen on takeover defenses and compensation packages. It's good stuff!

[williambraskyiii]

So are you saying investing in SSO is a bad idea? i was considering when the S&P was sub-700 and i am still considering