Shame on Standard. Phooey on Poor.
Standard & Poor's is tweaking the weighting formula on its various indexes, including its widely tracked S&P 500 benchmark, and I don't like it one bit.
Until now, the gauge has been a fair-market indicator, with 500 popular companies weighted according to their respective market capitalizations. So index fund investors could own appropriate chunks of hundreds of prolific companies with little fuss and even less ownership bias.
But now the S&P 500 will be adjusting its weightings based on a company's free float. In other words, instead of basing a company's value in the index on the value of its shares outstanding multiplied by its price (you know, its market cap), it will subtract those shares held by insiders as well as government and corporate holdings.
Standard & Poor's intention is noble. With $1 trillion invested in index funds, liquidity is a major concern. If there was a huge hypothetical company in which insiders owned all but a smidgeon of its shares, it would create volatility and share availability concerns for index fund managers buying in and cashing out of that particular position.
But it doesn't make it fair. The reason that five Waltons grace the list of the 10 richest Americans is because the descendants of Wal-Mart
In a nutshell, by the time the free-float adjustments are complete, Wal-Mart will be valued by the index at just 60% of what the stock market is saying. It may be the sixth most valuable company in the country, but to the liquidity-minded S&P folks, it will clock in as 12th. Other heavies with vested believers like Microsoft
It's a slap in the face, as these companies will be subject to selling pressure as index fund managers whittle down their stakes to the appropriate weightings. At best, it's an ironic solution to liquidity concerns.
Standard & Poor's claims that just 105 stocks will be impacted, but that's not true as index investors will be selling chunks of those companies and allocating the proceeds in the other 395. So companies like General Electric
But the ugliest aspect of all this is that the free-float adjustment is rewarding the unsavory. Insiders that sell in the open market and dilutive secondary offerings fluff up the float, and that suddenly makes the company more valuable? Bah! S&P? That's Shameless & Pitiful.
Are you a fan of index funds? Are you a subscriber to our Motley Fool Champion Funds newsletter? Do the S&P moves bother you as much as they do Rick? All this and more in the Mutual Funds discussion board.
Longtime Fool contributor Rick Munarriz can think of many other bad things to say, but he will mind his Ss and Ps. He does not own shares in any company mentioned in this story, and even if he did, he wouldn't be adjusting his portfolio weighting based on the float.