Big stocks driving up the index funds

Mutual funds

February 23, 1997|By Jerry Morgan | Jerry Morgan,NEWSDAY

Are stock index funds, which have had a great two-year run, pushing up the price of blue-chip stocks? Or are the largest companies simply outperforming everything else and, in doing so, driving up the prices of their shares and, as a result, the performance of index funds?

The answer appears to be the latter. The top 50 stocks on the Standard & Poor's 500-stock index seem to be pulling the train, with maybe a little push from index mutual funds that have to buy them.

Consider that the 500 S&P stocks have a total market capitalization of about $5.7 trillion, according to S&P officials, and that the index fund, pension and other money tied to the index totals about 8 percent of that, or $475 billion. That may be enough to give a little boost to the index, some say, but not enough to move it. The index funds that track the S&P 500 have to buy all the stocks in proportion to the weight those stocks carry in the index, based on their market capitalization. For example, General Electric is 2.85 percent of the index; Intel, 2.17; and Coca Cola, 2.43. But those weightings change daily as stock prices change.

Also, companies are dropped from the index and others are added as mergers, acquisitions and bankruptcies occur. Last year, 24 companies joined the 500. The index funds are constantly buying or selling the 500 stocks to maintain the correct proportions.

Even so, index funds alone couldn't have done the job of moving the index, said Gus Sauter, who heads the Vanguard Group's index stock funds, including the $33 billion Vanguard 500 Index Portfolio, which investors have made the second-largest equity fund.

"About $220 billion [in new cash] went into all equity funds last year, and only about 10 percent of it went into index funds," he said.

Index funds aren't the only ones that buy the blue-chip stocks. Some of the top stocks are held by thousands of equity funds, because they are very good stocks to own.

Still, the torrent of money doesn't explain why the 50 largest S&P stocks outperformed the rest of the index. If it was only cash flow, "there should be exactly the same impact on all stocks in the index," Sauter said. But that didn't happen. The top 50 S&P stocks rose 78 percent in 1995 and 1996; the bottom 50, 54 percent.

"My observation is that a lot of money is pushing the price of some of the indexed stocks, but there are also a lot of 500 stocks that are not performing as well," said Larry Puglia, who runs T. Rowe Price's Blue Chip Growth Fund, which is not an index fund.

There is one area where index funds do play a part in pushing up the price of some stocks, at least temporarily. When new stocks are added to the S&P index, they must be bought by the index funds and funds that tie their performance to the index. S&P normally announces new additions five business days before they go on the index, a company official said.

Anthony Young, an assistant professor of finance at New York University's Stern School of Business, and colleague Richard Mendenhall at Notre Dame tracked the price performance of those stocks.

"Basically, stocks that moved onto the index, to replace companies going off, saw a run-up of about 7 percent in their prices in the week before they were on," Young said. "Prices usually drop off about 1 or 2 percent soon after they are on the index."

The big-cap stock trend may not continue, said Arnold Kaufman, editor of S&P's advisory newsletter, Outlook.

"It is as though the popularity of the index funds has resulted from the good performance of the big companies" instead of vice versa, he said.

"But, at some point, the valuation of the big-cap stocks is going to become so far out of line in relation to the small-cap stocks that it is going to reverse."

Pub Date: 2/23/97

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