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  • Bogleheads on Investing with Dr. David Blitzer – Episode 2

Bogleheads on Investing with Dr. David Blitzer – Episode 2

Post on: October 30, 2018 by Rick Ferri

Episode Two of Bogleheads on Investing features an insightful interview with Dr. David Blitzer, Managing Director and Chairman of the Index Committee at S&P Dow Jones Indices (S&P DJI) with overall responsibility for index security selection, as well as index analysis and management.

In this episode, Dr. Blitzer discusses how S&P and Dow Jones came together under one name to become S&P Dow Jones Indices. He talks about the way securities are selected for the Dow Jones Industrial Average and S&P 500, and how stocks are categorized based on Global Industry Classification Standard (GICS). Dr. Blitzer also explores how the indexing industry changed as index investing became popular. Last, he comments on the difficulties active managers have in outperforming S&P Dow Jones Indices.

Prior to becoming Chairman of the Index Committee, Dr. Blitzer was Standard & Poor's Chief Economist. Before joining Standard & Poor's, he was Corporate Economist at The McGraw-Hill Companies (now S&P Global), S&P DJI's parent corporation.

This podcast is hosted by Rick Ferri, and is sponsored by the John C. Bogle Center for Financial Literacy.

You can discuss this podcast in the Bogleheads forum here.

Listen On

Rick Ferri: Welcome everyone to the Bogleheads on Investing Podcast,  episode number two. In this episode we have a special guest, Dr. David Blitzer, managing director and chairman of the index committee at S&P/Dow Jones indices.


Rick Ferri: My name is Rick Ferri and I’m the host of Bogleheads on Investing, a podcast made available by the John C. Bogle Center for Financial Literacy, a 501(c)(3) corporation.

In this episode we’re talking with David Blitzer, managing director and chairman of the index committee at S&P/ Dow Jones indices, who has the overall responsibility for index security selection, as well as index analysis and management.

Before Dr. Blitzer became the chairman of the index committee he was Standard & Poor’s chief economist. Dr. Blitzer can discuss many things with us about the Dow Jones Industrial Average and the S&P, which he is the head of the committee. But there’s one thing he cannot discuss. He cannot tell us is which stocks they are going to be selecting next for those indexes, which are highly confidential until the day that they’re announced.

However, today we are going to be talking a lot about the methodology behind the selection of various stocks that go in and out of the Dow Jones Industrial Average and the S&P 500, as well as many other indexes. In addition, we’ll talk about how the world has changed because of indexing. It’s no longer just a benchmark–it’s now an investment strategy-and that has changed the entire indexing industry.

Finally, we’ll talk about how active managers are having a very difficult time beating indexes, not only in the United States but globally, and how that is expanding the use of indexing and index products.

Let’s get to our podcast. With no further ado let me introduce Dr. David Blitzer of S&P/ Dow Jones indices. Good morning Dr. Blitzer.

Dr. Blitzer:
Good morning. You can call me David, and it’s a pleasure to be here.

Rick Ferri:
OK, Thank you David. Well you have a lot of responsibilities. How many indexes are you following at S&P/Dow Jones?

Dr. Blitzer: I guess two points of background to start off, we usually talk about something like a million indices produced on a daily basis, which sounds like an incredible amount, but one has to think about how indices sort of break down into other indices. If you think about the S&P 500, which is obviously a single index, but each company in the index is categorized into a sector, like technology, and industry group, and Industry and a sub industry. And for all those categories we create other indices as well. Plus we may have a version that’s equally weighted instead of weighted by market value, and so on. So the single S&P 500 by itself begets probably close to 500 indices and that’s how we get to this surprisingly high number of a million.

In terms of committees we actually have about forty-five committees organized by geography. By stocks versus bonds versus commodities and that kind of thing. In some cases we run indices in cooperation with an exchange. An example would be we run indices in Canada called S&P/TSX. TSX is Toronto Stock Exchange. There’s a committee for just those Canadian indices, which has people from the Toronto Stock Exchange as well as people from S&P/Dow Jones sitting on it.

I directly chair probably about 15 of the 45 committees and I sit on most of the other ones.

Rick Ferri: So it sounds like a lot of responsibility, especially since some of their biggest indexes we know of such as the S&P 500 and the Dow Jones Industrial Average are included in those. I have a question about that. It wasn’t always S&P/Dow Jones Industrial Average. When did it start to become S&P/Dow Jones Indices, as opposed to S&P indices and a separate company called Dow Jones?  It must have been some sort of a merger or acquisition along the way.

Dr. Blitzer: There was a merger, or maybe want to a call it a combination, that was completed in the second half of 2012. It was a bit of history beyond it, or behind it. To go back a ways the Dow Jones was originally owned by Dow Jones & Company, which owns the Wall Street Journal. I won’t get all the dates right, but around about 2005 or 2006, News Corp., which now owns the Wall Street Journal, acquired Dow Jones & Company. And following that, News Corp. looked around and they ended up selling it to the Chicago Mercantile Exchange, which people probably know because futures on indices are traded on the Chicago Mercantile Exchange, or the CME.

We roll forward a couple years, and the CME out in Chicago found itself running a bunch of indexes in New Jersey, had a big interest in indices also, and that is the futures on the S&P 500  traded on the Chicago Mercantile Exchange where we sometimes called the Merc. And at the same time S&P was very interested in what was going to go on because of the Dow Jones Industrial Average, which we knew to be a widely followed major index. And the result of this series of discussions and arrangements was that two firms got together and really brought a lot of complementary strengths. There were certain ideas that people at Dow had done which we wish we had done. One of the first really successful indices based on dividends was done by Dow, and very successful. And we’ve done some, but not quite as successful as that. They looked at us and we had been much more successful with big institutional investors and the 500 than they had been with the Dow, and it just made sense to put everything together. Obviously took a  lot of discussion and so forth but on November 1, 2012,  New York City was virtually flooded by a storm called Superstorm Sandy. We started doing business as one company.

Rick Ferri: Now if I recall correctly, prior to S&P and Dow Jones doing a business combination, so that your committee, or one of your committees, took over the Dow Jones Industrial Average; it was the editors of The Wall Street Journal who were picking the 30 Dow Jones stocks. Do they still have involvement in that?

Dr. Blitzer:  Uh yes they do. I don’t know the firsthand history of the Dow Jones Industrial Average before 2012 obviously because I come from the S&P half of the result. But there were–it was involvement in–from the editors of The Journal, and recognizing that huge long history of the Dow, it is the oldest stock index currently in existence and still being used, and so on. And the input that the Journal provided for, you know, almost 120 years at that point, we thought it was important to keep some involvement with them. And so we created a committee, or maybe you can say continued an existing committee, called the Averages Committee, which handles the Dow Jones Industrial Average, the Dow Transports, and the Dow Utilities. And that committee has five people on it. Three representing S&P/Dow Jones Indices and two from The Wall Street Journal. 

And sitting on that committee and chairing it it’s not only very welcome but very good to have two people from the Journal. They bring a slightly different perspective than we do in terms of how they see the economy and the markets, and developments in the news. They’re both very sharp and it’s worked out very well. And I think I’m very, very pleased to not just continue the role of the Wall Street Journal editorial group but really have two very good people on the committee.

Rick Ferri: I recall a conversation we had a couple of months  ago when the committee decided to take out General Electric from the Dow Jones. It appeared that it was going to be a big shock that GE was coming out of the Dow Jones Industrial Average, but it turned out that it really wasn’t a big shock. People quickly accepted that.

Dr. Blitzer: GE was one of the original members of the Dow and original meaning 1896. It had  been — in the first 15 – 20 years of the Dow, it was in and out a few times. But probably from the early to the mid 1920s, GE was continuously a member of the Dow Jones Industrial Average up until this year. And given the history of the company and its history with the index and so on, this is not something one does lightly. Obviously we don’t take any company out, or put any company in an index like the Dow lightly, but this one gets even more consideration.

GE has fallen on some difficult times. Various people have various explanations and so on. Since I’m not an analyst on GE in particular, I leave any of those details aside. But it had fallen on some difficult times and I think its weaknesses were widely recognized. And even though some people wanted to keep it in but as we looked at it in an index you only have 30 names because that’s the rules. We really thought we shouldn’t use the name on one stock that wasn’t doing that well. A lot of people didn’t think it was going to do that well, and given the way the Dow is calculated wasn’t having any impact on the index at all. So it was not a difficult call once we sat down to talk about it.

Rick Ferri: And it’s interesting you say that it didn’t have a big impact on the Dow because the Dow Jones is an unusual index. It is weighted by the price of the stock, which is that the larger the price the more influence or impact that a change would have on the index. And isn’t this one of the reasons why companies that have very, very large prices in the thousands of dollars may not work well in the Dow Jones 30?

Dr. Blitzer: That’s right. The Dow as you mentioned is unusual. The only other index I know that’s done that way is the Nikkei 225 in Japan, although I’m sure there are a couple of others that I haven’t come across. And when we look at stocks from the Dow we’d like the ratio between the highest price stock and the lowest price stock to be not much more than ten to one.  So GE when it came out was probably about 12 or 13 dollars a share. The highest price stock in the Dow at that point was around $200 or more. And since GE didn’t have much impact that $200 stock would have had you know 8 to 10 times the impact of GE on the value of the index. And it just didn’t make sense to do that, so we replaced it with a slightly higher price stock that we felt was a better representation of what was going on in the economy and the markets. And I think after the initial excitement wore off in a day or two we generally applauded and I think people are more comfortable with the Dow the way it is now than the way it was when we still had GE in the last days.

Rick Ferri: Let’s go over to the S&P 500. I’ve been in the business about 30 years and I’ve seen some pretty large changes to the methodology by which the S&P 500 is calculated. I believe back in the 1990s there were a couple of changes concerning it going from a full capitalization to float capitalization methodology. And then there was a change: what stocks are actually US stocks and what stocks are non US stocks. Could you talk about some of these big major changes that have occurred in the S&P over the last, say, 25 years?

Dr. Blitzer: Okay. The background that people should recognize is clearly the world changes, the economy changes, the way people use indices change, and so to run an index today the way it was run when, let’s say in 1982 when futures trading started, would be pretty silly and it wouldn’t work that well. And there’s been a lot of changes since then–probably the biggest change is the amount of money that tracks the S&P 500–which means it’s a lot more visible and changes, changing companies, makes a bigger difference and so on, than it did 30 or 40 years ago or something like that. 

The float change, I think, was actually in the early 2000s. The idea being that, well first the S&P had always had a rule that for stock to be in the index, or when it was added to the index, at least half of the outstanding stock should be available to the public. Let me add a company where the insiders or the founders, whatever, owned 80% of it the stock — that was nice, I’m sure they were doing very well — but it wouldn’t be eligible for the 500.

But even with that rule there was concern that we had some stocks that were just not very liquid and might be difficult to trade, especially in the low end or the smaller stock end of the index, and as trading and as exchange traded funds became bigger and bigger, those became something of an issue for a lot of people.

So what we did was we went to float where we go through once a year the proxy statements the companies file with the SEC. And we do our best to figure out what proportion of the stock is actually in the market, and what proportion is locked up in holdings by insiders, or holdings by another company. And holdings by another company would mean if both companies are in the index we’re sort of double counting. Things like Berkshire owns big chunks of various different large companies in the index, or where the stock just wasn’t available because the founding family wasn’t going to sell because they didn’t want to.

And so we made the adjustment to be what we call float-adjusted. So if a company had 80% of its stock in the index, we would count that 80% — excuse me, in the market — and we count that 80% as being available in the index and we take the total shares outstanding and multiply it by 0.8 and that would be the number of shares we use for index calculation. It was a fairly big change, although if you went took the most 500 stocks and just took an average of the percentage each company stocks or shares that was available in the index, it came out about 93 percent or something, so there were a handful of companies that there was this fairly big change, but the vast majority it was talking about a few percentage points change in their value as measured in the index.

The domicile, we call domicile, which is how do you know if this is a US company, which sounds sort of silly and obvious to most people but it got more complicated in about 2007, 2008, 2009. Two things happened. First a lot of US companies started changing their incorporation to Switzerland, Ireland, various places in the Caribbean, Bermuda. They all wanted to avoid paying US taxes. Which is again in the news in the last year or so.

And an issue the index committee is the first two or three of these came along, said you know those violate the rules because index is supposed to be US companies. It’s not supposed to be Swiss companies or Irish companies or whoever, and we started telling these companies now one by one. We then very quickly heard from a lot of investors, from individual investors who said “you know I’ve owned the company for 40 years and now you’re telling me it’s not what it used to be.” Some big institutional investors who are a little more vocal than the individual investors possibly. So we went around listening to people and talking to people. We hold an annual meeting called an advisory panel where we invite in a lot of major institutional investors and let them tell us what they like and don’t like about our indices.

And out of that came a feeling that what a US company should be is slightly different than where did you incorporate. The two key things that investors tell us about is, number one, how do you report your financial results? Do you report them to the SEC as a US company? Do you file a 10K and a 10Q That’s from an investor’s point of view? If you don’t do that then you’re not US; and second of all where does your stock trade, and there it’s pretty much New York Stock Exchange and Nasdaq. Those are the two major US exchanges that get mentioned.

And our rules now say if you do those two things and if you have at least a large portion of your assets, or your employees, or your activities in the United States you’re a US company. The last rule is there are a few Chinese companies that the only place they trade is New York and Nasdaq. They report on a 10K to the SEC. But all their business activities are in China, but we don’t think they’re US companies.

Rick Ferri: It’s interesting what you said about going out to investors, large institutional investors, and before you make a big change to the index you actually speak with the others in the industry and you speak with large investors in the S&P 500 and you get their input into changes that you’re considering before you make them, as opposed to doing it in a vacuum. Do you do that when you’re looking at potentially putting a new company in, taking a new company out? Do you get input from the industry? 

Dr. Blitzer: Well yeah I think we could hear the rules and regulations have been changing a lot over the years and so we should be very careful as to explaining what we do and don’t do. When it comes to considering adding a company or removing a company in the S&P 500, pretty much the same thing is true for any index, those discussions are absolutely confidential, and they are so confidential that the only people within S&P/Dow Jones will be permitted to be involved with them are those of us who work specifically on the indices, and for those of us the ones working directly in the indices, we cannot do anything commercial. I can’t quote a price. I can’t negotiate a contract. That’s completely off limits and so on.

So bargain moving things like adding a stock to the S&P 500, those discussions, that research, that analysis, is restricted to a very small group of people. Essentially the ones sitting on the index committee that covers the index. And we don’t talk to anybody until we publish an announcement on our website and give it to the news media, which says this company is being added on such-and-such a date, or this company being removed. So those kinds of discussions, the ones that are really market moving, we keep them under wraps. Other discussions, much more general things like how would you define what company is a US company, so those we will invite comments. What we do the vast majority of times is we’ll publish a letter or paper on our website and explain what the issues are and ask people to send us their comments. In fact they can go on our website and fill out the information right there and at the same time if we know of investors, whether institution or individual, who will be, have an opinion, or be interested, we want to make sure we hear from them and we will send them an email and say we just published a consultation on this matter and we would appreciate a response.

So that we do reach out with that, but even with those if we’re doing a consultation on a particular question we’ll ask a lot of input from people, but we’re not going to tell anybody what we’re going to do until we publish the results for everybody. So we’re very concerned that crucial information, all investors have equal access, the same time, same information and so on. And if we’re toying with something that’s going to be market moving we’re going to keep it to ourselves until we tell everybody at the same time. That’s the way we run what we feel is a fair and transparent index.

Rick Ferri: Is it fair to say that if a very large company comes out of the index then you’re trying to find an equally sized company or something close to it, like you talked about with the Dow Jones Industrial Average price as far as the S&P given a cap weighted index if a hundred billion dollar cap weighted company comes out are you looking for something close to that to put in?

Dr. Blitzer: I’m not sure they’re too many hundred billion dollar companies floating around there that are not in an index actually.  For the 500, there are a series of rules. One we mentioned already it has to be a US company. Its market value should be, currently I believe the minimum is about six point eight billion dollars at a minimum at the time it goes in. It should be profitable, meaning on GAAP earnings it should have made money a little last year. And that’s an unusual rule for an index. It should be liquid; if it’s not liquid somebody would have a hard time trading the stock and so on.

So those rules are public and a company we choose should comply and does comply with those rules and so on. And all that’s published and I think all the US indices’ methodology is up on our website. Some people may tell you it’s a great cure for insomnia but other people tell you it’s actually worthwhile reading.

Rick Ferri: All right, thank you. Let’s get into some big changes that have taken place in industry classifications that have occurred over the last couple of years. And you could probably start out with an overview of the Global Industry Classification System GICS, or standards is it? And what that is and then how does that all work into the S&P and what you’re doing and it’s a global change, it’s very large changes that have taken place. Can we talk about that?

Dr. Blitzer: GICS is the Global Industry Classification Standard. It’s the system for classifying companies into a sector, which for example, would be technology or health care, an industry group and then within that, within an industry group there’ll be one or more industries, and within each industry there’ll be one or more sub industries. So that at the very bottom there are around 160 sub industries, which is a pretty detailed statement as to what a company does.

And classification is done potentially by looking at where the company gets its revenues. We also will look at earnings, and at times we’ll look at the way the market perceives a company, and that the market sometimes sees the company is doing one thing even though it does something else that’s a little bigger.

GICS is an effort that’s maintained or run jointly by S&P/ Dow Jones Indices and MSCI.  We’ve been running it together since it was created in about 1999, and on a global basis — I don’t remember the exact numbers — but essentially any publicly held company anywhere in the world that an investor is likely to even look at has a GICS classification sector, industry group, industry, sub industry.

Somebody sort of wonders why do you do this? Well the way investors think about markets and what moves markets is they like to have an idea which ones are going up and which ones are going down, because it’s very rare that everything moves together. So somebody will say the S&P 500 was up 3% last week, it was led by the technology stocks and healthcare but consumer discretionary lagged or something of that sort. Those are all names of the major sectors and people will then tell you what portion of the 3% was contributed by each sector so I’m going down so to reduce the 3% other ones pushed it up. They’ll look over periods of time, what’s been growing fast, all that kind of thing.

So this year people have talked about technology stocks leading the way and so on. And the way they decide whether that’s not true or not, is they’ll look at the S&P 500, and then look at how the technology sector within it has done, and in fact we calculate the S&P 500, we calculate the technology sector as its own index, and you break it up into a couple of industry groups and industries. We calculate indices for all those as well, so you can take that data  and you can see exactly what went up and what went down on the market, by how much, what was pushing the market one way or the other. You can look at did things change over time; did certain areas react a lot positively and negatively to changes in government policy; just about anything. It’s really the way to take the stock market and sort of peel back all the layers and understand what’s going on.

Rick Ferri: So some of the major changes that have occurred in the last couple of years. Real estate investment trusts or real estate was part of the financial services sector. You broke that out now and made it its own industry group, which would include real estate investment trusts or equity. So you saw  that as a significant enough part of the market now to give it its own industry classification.

Dr. Blitzer: That’s right. When GICS started back in ’99, other than a handful of real estate investment trusts, there wasn’t much real estate in the stock market to begin with. And we just tucked it under financial, figured well, all that matters is what the mortgage rates look like, so let’s stick it there. Coming out of the financial crisis in 2008 -2009, well first of all everybody knew where real estate was because it had had a role in the financial crisis. But second of all, as interest rates came down and investors started looking for income, real estate and particularly REITs, became an intriguing thing. The way REIT are structured they tend to pay very, very high dividends relative to their size. They were getting more understood and indeed that sector was growing, so we looked at that and we said real estate is increasingly important and maybe it should really be in its own sector. Instead of ten sectors we ended up having 11 sectors.

In the process of doing that, we did do a lot of surveys, and talked to a lot of people, institutional investors, individual investors, some brokerage firms, some brokerage firms that really focus and specialized in real estate and REITs in particular. And out of that we, and in this case it’s both S&P/ Dow Jones and MSCI working together, felt that real estate deserved to get a little more prominence and we sort of pulled it out from being buried in finance.

The other thing is that maybe back in 1999 real estate and financials sort of behaved the same way. By the time you roll forward to the last few years they weren’t behaving the same way at all, and putting them in the same sector when one would go up when one would go down wasn’t really helping anybody was trying to understand what was happening. If anything it was just muddying the waters, so we split it out.

Rick Ferri: Big change occurred here last month with telecoms and technology turning into now technology and communications. And it was very big because now companies like Facebook, Walt Disney, Alphabet, which is Google, I mean some very big companies that we investors have always said well if I want to get exposure to those companies, all I have to do is buy a technology index fund. That has now changed. If I wanted to buy an industry-specific index fund to get exposure to Facebook or to Google I now need to buy something called communication services because it’s not being looked at as a technology company anymore.

Dr. Blitzer: That’s true and I guess there the background is maybe more detailed, but I think more interesting than in the real estate story. First thing to say is for the S&P 500, telecom had gotten down to three companies, number three wasn’t very big either. So something really ought to change but in fact we had been discussing this and looking at this for three or four years going, and as we looked at it we realized that the whole span of what is technology, what is communications, what’s telecommunication, was undergoing a whole lot of rapid change. Give you a sense, iPhones are about ten and a half years old. Eleven years ago nobody had an iPhone, it didn’t exist. Nobody had a smartphone because the iPhone was essentially the first smartphone. Roll back even a few more years, certainly the beginning of the century, but probably well in the first decade, if your company had a website that was pretty high technology. Nowadays nobody will admit they didn’t have, haven’t had a website forever. And how did people communicate 10-15 years ago? It was a telephone like the one we’re talking on right now has wires.

Email was sort of a rarefied thing. You had to be in a university in, you know 1995, to have email, it just didn’t exist. Nobody texted anybody because nobody quite knew what that was and probably a few people still remember telegrams. So the world has really changed a whole lot.

Rick Ferri: Well I remember telegrams.

Dr. Blitzer: So do I, I once sent one or something, but anyhow we don’t want to date ourselves too much. As we started looking at this and we said all right, what are all these things doing and they’re doing communications. Some of it’s sort of back and forth two-way communications, what we’re doing right now, some of it’s broadcast communications, and part of communications is movies, television, streaming, streaming anything and everything. Unlike entertainment or virtually long entertainment, all of that is part of communications. And on top of that companies are jumping from one part to another part to another part. AT&T and Verizon, one of them owns a chunk of Time Warner, the other one owns Yahoo and so on.

So this is all change. For most people communicating today means reading about their cousins on Facebook or sending texts on WhatsApp or on and on and on. So it’s all changed but it’s all blending into each other in terms of the way the companies operate. And on that basis not only did we realize telecommunications, the old definition didn’t make any sense, but we really had to understand what the new thing should look like. Facebook is very much the way people communicate. And it’s not to say anything improper or unkind about their technology but their real business is advertising and helping people communicate. And Google is very much the same way, their real business is advertising and search. Advertising is a kind of communications.

So that’s the reason for the change. Yes I admit that a few companies you used in love in technology you have to look a little bit farther to find them, but I think if you asked them or looked at their financial statement you discovered they’d been in communications for the last few years if not longer.

Rick Ferri:  Getting back to indexes in general. Back when I entered the business, indexes like the S&P 500 were not used as a way of investing, or as a portfolio. There was one index fund from Vanguard that was out there, and which I know you probably have an interesting story about and I’d like you to share with us if you could. 

This has become a big, big business– indexing for the purpose of investing as opposed to indexing for the purpose of benchmarking, or indexing for the purpose of economic measurement. With the advent of indexing for the purpose of investing, if it goes into a product, that has significantly changed not only your business but also the whole indexing business for all the different index providers. And could you talk about the business a little bit and how things have changed because indexing is now a product for investing in as opposed to just a benchmark or economic measurement.

Dr. Blitzer: Okay when indices actually started, they probably started as advertisements. I mean the best I can tell from reading the history, Dow Jones started the Industrials because they wanted to get people to buy their newspaper. And it was a feature of the newspaper to have a number that would tell you what happened in the stock market yesterday. The S&P 500 started in 1926 as something called the S&P 90. Standard and Poors, in those days there were two companies called Standard Statistics, and they were financial publishers. They published newsletters about how to invest, and that’s why they started an index as well.

The first individual investor product based on indices was Vanguard’s, and you mentioned that you’ve interviewed Jack Bogle also. He can tell you much better than I can first hand; he’ll probably tell you that they didn’t have much money at the end of the first year, and everybody told him it was un-American because they were just going to be average and so on. We’ve got hoards of data that proves that the indices, in most quarters, in most years, outperform three fifths to two thirds or three fifths of all the active managers out there. So if being average is beating three out of five people I’ll be satisfied being average. 

But in terms of the business, and I usually say S&P 500 was present at the creation. It was the first index in a retail mutual fund with Vanguard. It was not the first index to have stock exchange index futures traded on, it was the first one that was successful and lasted, for any length of time with the futures at the Chicago Mercantile Exchange. It was the first index in the United States with an exchange-traded fund, with the big Spyder, in about 1993, and it’s very much still here, and by most measurements it’s the biggest index period. So it really has been present at the creation.

In the process, it did turn indexing into a business. I joined S&P by dumb luck, about six weeks after futures trading in the 500 started, which also was the first year that instead of being a cost center everybody thought might actually be a profit center and indeed it’s become that over time. And the growth has been very strong and very nice and I think it still has a great future ahead of it.

And we go through sort of different steps, and so on, quickly. At the same time the number of indices have increased the variety of indices, which really means the variety of tools from investors, has grown dramatically. I think I mentioned earlier indices designed to provide dividend income which are very popular with investors. Indices to target segments of the market. You know we talked about technology stocks and so on. Indices that focused on growth stocks or value stocks. Or it goes on and on. So increasingly any investment strategy that somebody can think up and write down as a set of rules or set of steps, somebody else could build an index for, and provide it to any investor who’s interested.

Rick Ferri: It makes it a little complicated because now you have to differentiate between traditional indexes, or indexes as benchmarks and indexes as strategies, investment strategies, where any you know a set of rules would is all you need to create what’s called an index. And including in that rules is how you weight securities, which it doesn’t have to be cap weighted, it can be weighted any number of different ways as long as it follows some sort of a strategy. So it gets a little bit confusing for investors.

And we’re trying to come up with a differentiation between Jack Bogle, likes to call them traditional indexes; I like to call them benchmark indexes versus strategy indexes, and there’s a lot of talk about how to differentiate the two. Do you have a differentiating term that you use for that?

Dr. Blitzer: We probably don’t have a term that has been widely accepted or something like that to break one group off from another or something. Inside it gets to be too much jargon. People call that FMC, that means float market cap, which is what you call a benchmark index. But if we wrote that in all the publications everybody would scratch their head. So we don’t.

I would agree there’s a huge number of different indices out there and there are different building blocks in different ways. The two things to remember sort of as a basis is you’ve got to do two things in building a stock index. You have a way to select the stocks, and you have to have a way to weight the stocks. And if you sort of stick with those, looking for those two things, an investor should be able to get a sense of what’s going on.

You know if the selection talks about a certain industry or fair stock that has continuously paid dividends for the last 25 years, that tells you something about what kind of stocks people are looking for. And then if they look at the weighting rule they can also have some idea of what’s going on. It’s a little more subtle maybe, but if you start by saying the market is market cap weighted, that’s the way the market is, it’s all stocks out there together: Apple, Google, Facebook, they’re big ones, they carry more weight in the market than some stock that’s by size order number 400 down the list, or number 2,000 down the list or something like that. As soon as I change that I get different results from the market weighting.

If I make it equal weighting, which is sort of easy to see, the little stocks are gonna get more weight and the big stocks gonna get less weight and that’ll change the results. If you want to see the impact, we run the S&P 500 both ways. If I weigh them by the dividends they pay, I’m going to get a lot more weight, a lot more bang from the big dividend stocks and so on. It gets a lot more complicated as I go down the list, but I think you stick to weighting and selection and you’ll have some idea what’s going on in the market.

And I should add nobody knows everything that’s going on in the market so don’t go down that trail; you’ll never get to the end.

Rick Ferri: They don’t? Oh that’s not what they say on television.

Dr. Blitzer: I know, but given how long I’ve been doing this, you’ve been doing this, Rick, I don’t know about you but I learned nobody knows everything in the market, and I like indices because I’m not a great fan of picking the one stock that will go up this year.

Rick Ferri: You know getting back to the way in which indexes are created with the selection on one side and the weighting on the other, I don’t know if you recall about ten or twelve years ago I created this thing called an index strategy box which showed the three different basic, different buckets for selecting securities, which are basically covering the market; and then screening the market; and then a quantitative method where you pick just a few stocks as a selection methodology. And then on the bottom I had capitalization weighted, fundamental weighted, and then fixed weighted. And all the different indexes that were being created sort of fell into one of these boxes very nicely. It never took off but it’s the same exact- I’m glad to hear it the same thing that you’re saying now is. It really hasn’t changed very much.

Dr. Blitzer: Okay yeah I remember it in general. I won’t swear I remember every box in detail.

Rick Ferri: Got it. So indexing though in the US really seems to be the leader. You know we here in the United States have investors are now embracing indexing and I personally believe a lot of that has to do with exchange-traded funds and the ability of ETFs to reach a much broader, wider audience in the brokerage industry and in other places. But indexing, and in core type indexing portfolios which seem to be getting them the most money, have really grown in the United States. but overseas where they seem to be in some places twenty years behind us, but they’re getting there. Did you see that growth just continuing? 

Dr. Blitzer: I do think the growth will continue, but I think there are some countries which you might say have an equity mentality or an equity mindset, and other ones that have much less of an equity mindset. Certainly we do business in Canada. We do business in Australia. In both cases with the major stock exchange in each country, they are as focused on equities as the United States is. Their attention, their sophistication, their analysis, is comparable to the US and so on. And the UK also has a big equity mentality and so on. One of our competitors owns sort of kingpin indexing in Great Britain, we don’t but we definitely are active there.

But there are other countries, maybe Germany’s one that stands out that traditionally investors invested through banks, they held a lot more fixed income or a lot more structured products of various kinds, than they held equities and invested directly in stocks the way Americans traditionally do. And as a result the whole pick up in ETFs and exchange-traded funds is probably a little bit slower. Hong Kong has a very active market. China has two major stock markets, the volatility occasionally worries everybody no matter where they are, but there’s certainly plenty of equity expansion and ETF growth in a lot of places around the world.

Rick Ferri: And it seems to be universally around the world as well when you’re measuring the performance of S&P/Dow Jones Indexes to active management, that’s fairly universal around the world that you get this three out of five managers underperform. Your SPIVA has really grown. This SPIVA is looking at the performance between active and your indexes and you’ve  been doing that for now I think for 20 years. You alluded to it a little earlier. But that’s also expanded. Now you’re doing more and more countries and you’re looking at this phenomena occurring across more countries. And did you think that might help to increase the indexing?

Dr. Blitzer: Yeah I think it has, when we introduced SPIVA which was an acronym for S&P Index Versus Active, it was really to try and establish a benchmark to compare active managers to our  indices and so on. We did it in a way that we felt was fair and so on, and it’s been very well received. I think the surprising part was we really thought this was strictly for individual investors who didn’t have access to reams of fancy institutional research. A few years in, we suddenly discovered a lot of pension funds from municipalities, the police department here, and the fire department there, their trustees were calling up and saying “will you send me the latest SPIVA  report?” They were sitting down in their quarterly meeting and looking at managers they had hired and say “why can’t you do this well?” and so on. So what we thought was a low key thing for the average guy suddenly turned out to have a lot more impact than we expected.

But I think it’s good reliable data. Indices don’t win every time but they do win more often than not and I guess it’s playing the averages you come out ahead.

Rick Ferri: It’s a good business to be in.

Dr. Blitzer: We like it.

Rick Ferri: This concludes the second episode of Bogleheads on Investing. I’m your host, Rick Ferri. Join us each month to hear a new special guest. In the meantime visit Bogleheads org and the Bogleheads wiki, participate in the forum, and help others find the forum. Thanks for listening.




About the author 

Rick Ferri

Investment adviser, analyst, author and industry consultant



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