The S&P 500: Our Industry’s Oops

Head of Equity Strategy
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The S&P 500 Index has not been around as long as you think. I encourage you to investigate the events that led to it becoming a $9.9 trillion monster.   


You know the methodology: each of the 500 stocks is weighted by its market capitalization. The supposed catalyst for choosing that methodology in 1957? The Efficient Markets Hypothesis (EMH)—the theory that all market-influencing information is already priced into stocks.


But wait a minute…that may not have been the catalyst at all.




There is a dog-eared copy of Princeton Professor Burton Malkiel’s EMH groundbreaker, A Random Walk Down Wall Street, on every good academic’s shelf. But after EMH was challenged, first in the wake of the 1987 market crash and then amid the rubble, Malkiel picked up his pen in 2003, citing no less than 57 works on the subject. Aside from Graham and Dodd—two academics who epitomize the opposite of efficient markets dogma—every single paper cited by Malkiel was written after 1957.


The S&P 500 Index wasn’t designed to be an investment. We know this because it came before the EMH. Don’t forget that Jack Bogle’s index fund was born in the mid-1970s, not a moment earlier.


Figure 1: Malkiel’s Citations

Malkiels Citations


What do we think? Cap-weighted indexing as an investment is an accident of circumstance.


In retrospect, the rise of the methodology makes sense. The industry rightly benchmarked active managers against the commonly-cited S&P 500. The fund managers weren’t so bad; their fees were. It wasn’t that the S&P 500 was so superior; it was that it was being compared to mutual funds hindered by their own expenses.


Here’s a simple study: 1957–2018, weighting stocks by their earnings. Every December 31, rebalance. If S&P wanted an investable index, this earnings-weighting would have been a killer.


Figure 2: S&P 500 P/E Quintile Returns, 1957–2018

SP 500 PE Quintile Returns 1957 2018


Take the huge fee gap out and ask why old school beta makes sense in a 2019 fee structure world.


We recently cut the expense ratio on our earnings-weighted broad market “beta” fighter, the WisdomTree U.S. LargeCap Fund (EPS), to 8 basis points (bps) from 28 bps. Some chunk of the S&P’s $9.9 trillion is tracking an accident of happenstance for fee reasons, not merit. Think of EPS as merit-based beta for those of us who believe fundamentals matter.


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About the Contributor
Head of Equity Strategy
Follow Jeff Weniger
Jeff Weniger, CFA serves as Head of Equity Strategy at WisdomTree. In his role, Weniger helps to formulate the firm’s stock market outlook by assessing macro and fundamental trends. Prior to joining WisdomTree, he was Director, Senior Strategist at BMO, where he worked in the office of the CIO from 2006 to 2017. He served on the firm’s Asset Allocation Committee and co-managed the firm’s ETF model portfolios for both the U.S. and Canada. In 2013, at the age of 32, Jeff was chosen as the youngest member of BMO’s Global Investment Forum, which collected the firm’s top global strategists to formulate the firm’s official long-term outlook for investment trends and markets. Jeff has a B.S. in Finance from the University of Florida and an MBA from Notre Dame. He has been a CFA charterholder and a member of the CFA Society of Chicago since 2006. He has appeared in various financial publications such as Barron’s and the Wall Street Journal and makes regular appearances on Canada’s Business News Network (BNN) and Wharton Business Radio.