The Mis(Uses) of the S&P 500

Abstract

The S&P 500 is widely used as (i) a means of directing investor capital through “passive” investing, (ii) a benchmark for evaluating the performance of investment portfolios or managers, and (iii) a means of evaluating the performance of firms or corporate managers. In this paper, I argue that in all three contexts, a pervasive misunderstanding of the S&P 500 leads to substantial misuses of the index. I show that investing in a fund designed to track the index is a form of delegated management and does not accord with the conventional concept of “passive” investing. I then show that using the index as a benchmark implies a comparison to something that is neither passive nor neutral. Finally, I show that using the performance of the index to evaluate the performance of the index’s constituents leads to biased results, calling into question the usefulness of this practice. In all three contexts, I quantify the magnitudes of the resulting errors and show that they are large and significant. I then discuss the implications of these findings.

Keywords: stock market indices, S&P 500, securities, mutual funds, passive investing, active investing

JEL Classification: K22, G11,G29