Some Indexes Matter, And Some Don’t

A little over two years ago, we decided the long term evidence of trying to select actively managed equity funds in comparison to their index peers was too compelling to pass up, and thus we switched virtually all equity exposure in client portfolios to ETFs (exchange traded funds) that represent various indexes and parts of the stock market. Mind you, we are still tactical in deciding how much exposure to have, but this was about WHAT we should own.

Today, there are more indexes than stocks, and as you will see below, there is a lot of overlap in many areas (large cap, mid cap). We had to narrow the universe down to a manageable level and eliminate redundancy. So, we went about the process you will see below, essentially comparing the four largest providers of ETF indexes against one another in each category.

Those providers are Blackrock, Vanguard and Schwab, but note that Blackrock has its own brand called iShares, which use both the Russell indexes as well as the S&P Indices (Standard & Poor’s). As it turned out, Fidelity Investments, the custodian we use for clients, introduced a list of ETF’s that advisors could trade on behalf of clients with no commissions. In former days, that might have been a really great incentive, but it is no longer, not when the vast majority of our clients are eligible to trade stocks and ETFs for as little as $4.95 per trade, as long as they are using electronic delivery for their documents.

Nevertheless, if you have ETFs in a category that are the best performing AND you can buy or sell them with no commission, why not use them? We went about evaluating the choices by looking at just a few metrics, which included the expense ratio, intermediate and long term performance, and size. The data you will see below is current, and continues to confirm the choices we made in the summer of 2015 in terms of creating our custom matrix.

A Little Bit About Composition

Before we get into the comparisons of large company indexes and others, it is appropriate to talk about the differences in how some indexes are computed. Most indexes we will be discussing are cap-weighted, meaning that the stocks with the greatest capitalization have the greatest weight in the index. The most popular of the cap-weighted indexes is the S&P 500, which accounts for about 80% of the market cap of U.S. stocks. In its case, the top 25 stocks, or 5% of the index, currently account for 32.5% of the index.

Currently, the top five companies in the index and their respective weight are Apple (4.05%), Microsoft (2.87%), Amazon (2.07%), Facebook (1.92%) and Johnson & Johnson (1.65%).