This isn't your father's S&P 500 index. For example, as of March this year technology accounted for 18.2% of the market capitalization of the Standard & Poor's 500, up from just 5.5% in 1964. Now it's significantly higher. Finance stocks in March accounted for 16.5% of the market cap of the index; in 1964 they accounted for zero. Health care in March was 12.1%; in 1964 it was 2.3%. Consumer durables in March were 1.9%; in 1964 they were 11.3%. Utilities were 11% in March; in 1964 they were 19.2%. Overall, the index today is less cyclical and more diversified.
On top of these obvious changes, there are more subtle differences. The S&P 500 today is more global than it was in 1964, because many more of the companies in it have global operations. The trend to globalization is a wonderful development in many ways. For example, it makes it easier for countries to exploit their comparative advantages.
But there are unexpected side effects of globalization, effects that are not always visible and that show up in unexpected places.
Many investors are somewhat aware of the structural changes in the index. Few are unaware that technology stocks have become a major part of it. But investors -- institutions and individuals -- who have some of their money in S&P 500 index funds probably still think of them as a conservative, relatively low-risk domestic investment. I plead guilty.
However, an analysis by Quantec America, the London- and New York-based quantitative consulting firm, shows this is not so. In fact, more than 50% of the S&P 500's total risk is attributable to its stocks being a subset of the global equity market.
How can this be? Simple -- the companies in the S&P 500 index increasingly are exposed to global risks and opportunities because most have foreign manufacturing operations. Most have foreign sales. These operations, and hence their earnings, are affected by economic and political developments in foreign countries.
In addition, the companies are exposed to currency risk. In fact, more than 30% of the S&P 500's total risk, according to the Quantec analysis, comes from currency exposure.
The implications of this analysis bear consideration. The most obvious is that many investors have taken on far more international risk than they realize.
They might have committed 10% of their portfolios to international equities because that was how much they were comfortable with, and they might have 30% in an S&P 500 index fund as a conservative anchor.
But the Quantec analysis suggests the effective exposure to international is far higher.
"Investors using index funds, and even many actively managed domestic portfolios, must be aware they are taking on currency risk," said Jason MacQueen, chairman of Quantec.
Then, of course, you can decide if you are comfortable with that level of foreign exposure and adjust either your international position or your index fund position, or hedge your total foreign currency exposure.
Mr. MacQueen suggests a longer-term strategy: "Stop thinking in terms of country allocations at all." That is, don't think about investing so much in U.S. equities and so much in foreign equities; rather, "think in terms of allocations to global sectors. Think of the market as a global market and the S&P as a subset of the global market."
That's easier said than done. We all tend to think in local terms, and it will take an effort for our thinking to catch up with the globalization of the world's markets. But perhaps recognizing the global exposure of the S&P 500 is a way to start.