What a difference a decade makes.
Ten years ago, capital goods, utilities and energy were the hot sectors in the Standard & Poor's 500 stock index. Today those sectors are mere shadows of their former selves, outflanked by technology, financials and health care, which now command the biggest weightings in the index.
The only sector that has remained relatively unchanged is consumer staples, which had a 14.9% weighting in 1998, vs. 14.1% in 1988.
S&P has maintained the same 11 sectors for 10 years, but many of the subgroups have been reorganized.
Elliott Shurgin, vice president-index products and services at Standard & Poor's Corp., New York, noted in an interview that the biggest changes in the past 10 years occurred in the utilities and energy sectors.
Utilities, which have shrunk to 3.1% from 11.3%, became so small because the Baby Bells were removed from the sector after deregulation. The energy sector also has done a big disappearing act, slipping to 6.2% from 11.8%, because of the death of the coal industry and the consolidation and relative underperformance of oil stocks.
Technology, which commanded the largest weighting in the index in 1998, surged by 75% to 18.5% from its 10.6% weighting in 1988. Financials practically doubled, rising to a 15.4% weighting from 7.8% in 1988.
"The weightings of the sectors and the companies within them are meant to reflect the American business landscape," Mr. Shurgin observed.
That view was aptly illustrated last week when on the first day of trading in 1999 America Online Inc. replaced Venator Group, Inc., the specialty retailer formerly known as Woolworth's. AOL is the first Internet company to be added to the index.
"The old Woolworth's had a significant role in the U.S. economy for 50 years, but in the last five years it no longer was the same company it used to be," Mr. Shurgin said.
"When we make changes, we try to add companies that are representative of American business today."
Changes to the index also occur when companies merge, are delisted from an exchange or go into bankruptcy. At other times, such as when S&P wanted to add Lucent Technologies Inc. to the index after it was spun off from AT&T Co. in 1995, S&P had to remove a company with a small market capitalization. Often those are companies whose stocks have been performing poorly.
Adding and subtracting
In the past decade, some subgroups within the index sectors have been eliminated completely, such as coal, which was killed off in June 1993; air freight, removed in April 1989; services-payroll, deleted in January 1997; and machine tools and conglomerates, each deleted in June 1996.
Several new subgroups were added that month, including biotechnology, computer services, gaming, payroll services, telecommunications-cellular, electronics distribution, health care-long term; health care-specialized services; oil/gas refining; computers-peripherals; and computers-networking.
Another set of subgroups has been renamed to more accurately reflect current business: toys is now leisure-time products; pollution control has become waste management; heavy-duty trucks is trucks and parts; hotel/motel is lodging; broadcast media is broadcasting; aerospace is aerospace/defense; personal loans is consumer finance; and shoes is footwear.
In the past 10 years, 321 changes have been made to the index, Mr. Shurgin said. But 271 companies that were part of the index in 1988 remain today.
Another major change in the index is S&P's policy of announcing removals and additions before they are made, which took effect in 1989. Before that, the announcements were made on the day they became effective.
With the advent of the announcements, "more big investors have been gaming the changes," said Judy Bednar, director of passive equities, Northern Trust Quantitative Advisors, Chicago. "Some buy the stock right after the announcement and sell it on the date it becomes part of the index. And they short stocks that are to be deleted, on the assumption the price will fall, and buy it back at the low price to close out their positions."
In addition to indexers, institutional brokers and traders as well as active managers have been using the "gaming" strategy, which has resulted in big price changes in upcoming additions and deletions to the index. Most recently, the share price of AOL jumped 18% following the news the company would be added to the index.
Many managers trade on rumors of what they think will be added to the index, Ms. Bednar said.
Leo Guzman, who heads Miami-based institutional brokerage Guzman & Co., lists candidates that are likely to be next: AFLAC Inc.; Network Associates Inc.; Office Depot Inc.; and Berkshire Hathaway Inc.
Many investors are eager for the inclusion of internet companies Yahoo! Inc. and Amazon.com Inc., he said. "But it's unlikely to happen until they turn a profit," he noted.
The early announcements have completely changed the return patterns, said Arlene Rockefeller, principal and head of global enhanced equities at State Street Global Advisors, Boston.
In the period between 1990 and 1995, stocks that were being added to the index rose 5% before they were included. Now they rise 9%.
As an index manager for large pension funds, SSGA's strategy has been to search for buying opportunities when a stock is being added.
"We usually start purchasing soon after an announcement. But sometimes we'll finish purchasing after it's been added, because the price may go down by then," Ms. Rockefeller said.
Recently, a "last-day effect" has kicked in, too, she observed. For example, when S&P announced it was dropping Chrysler Corp. from the index, the stock fell 9%. Chrysler was dropped after it merged with German auto maker Daimler-Benz AG, because only U.S. stocks are included in the index -- except for some that were grandfathered in years before.
J. Parsons, managing director and head of equity management and trading at Barclays Global Investors, San Francisco, said his firm changes its buying strategy with each addition to the index.
"There tend to be excess gains on an announcement, which are given up in two to three weeks. The pre-announcements can spread the impact of an addition over several days," Mr. Parsons said.
"It's important for Barclays to mitigate the price impact an addition can have," he said, "so its passive investor clients aren't losing money."
Changes in the index are made by the S&P index committee, which consists of nine S&P managers and analysts. David Blitzer, S&P chief economist, is chairman of the committee, which meets monthly. The analytical staff presents recommendations to the panel based on stock guide data, sector weights and market capitalizations of various stocks.
America Online was added to make the index more representative of the U.S. economy, Mr. Shurgin said.
"It was a judgment call to drop Venator for AOL. You could take issue with it. But the committee decided on AOL because it has strong liquidity and is actively traded," he said.
The committee's mandate is to add companies that are seasoned, that have a history of being profitable and that are viable enterprises that are likely to be around in 10 to 20 years.
Companies are not eligible if more than 50% of shares are closely held or if they are not U.S.-based, although several foreign companies have been grandfathered in.
The weightings of different stocks are changed as companies issue shares or buy them back.
Since many of the changes have been spurred by mergers and acquisitions, their pace has influenced the number of changes to the index.
In the '80s, when companies were being gobbled up at a record pace, there were an average of 25 to 30 changes a year in the index, Mr. Shurgin recalled. When the pace slowed in the early '90s, there were fewer changes. But in the last couple of years, as mega mergers became weekly events, the index has had close to 40 changes a year.
10 lead the way
In 1998, the index gained 26.6%, but 10 of the 500 stocks were responsible for almost half of the market capitalization-weighted rise, said Jeffrey Warantz, an equity strategist at Salomon Smith Barney.
"Thus, if one calculates gain the way the S&P does, the other 490 names have risen only 11.8% this year. And 50 of the S&P stocks were responsible for 94% of its gain. The median gain for the bulk of the S&P stocks was a scant 2%," Mr. Warantz said.
The 10 stocks that contributed to 50% of the rise were: Micosoft Corp.; Wal-Mart Stores; General Electric Co.; Lucent Technologies Inc.; Cisco Systems Inc.; Intel Corp.; IBM; Dell Computer Corp.; Pfizer Inc.; and Merck & Co.
Most of those are growth stocks that don't pay dividends, Mr. Warantz said, and as a result, the yield of the S&P index had fallen to 1.5% for 1998 through Nov. 1, compared with a 3.6% yield at the end of 1988.
Barclays' Mr. Parsons said that the narrowing of trading in the S&P 500 is the best argument he could make for indexing.
"If you're in the index, you won't miss out being in the right 10 stocks. The more consolidated the returns are, the more important it is to be indexing, since the odds of choosing the wrong stocks are great," he said.
