More than 30 stocks might be removed from the S&P 500 | Index Adds and Deletes | Passive Investing

Passive investment indexes in times of market volatility have become a subplot of the recent drama in markets, following wild moves in the oil market. It’s looking like things could kick off in stocks, too, as index overseers consider ejecting underperforming companies.
In indexes like the S&P 500, dozens of companies are at risk of deletion, after shares dove in March. While index compilers are guided by rules, they must also use their judgment in assessing the market right now: how much of the recent plunge will turn out to be permanent?
The S&P committee is going to have to decide how long to wait before ejecting impaired companies, The S&P 500 may be the world’s most-followed passive index, but the recent market volatility is going to force its constructors into some very active choices.
More than 30 firms might be removed from the S&P 500.

The S&P500 has staged a remarkable recovery since March, a rebound whose strength is largely due to its weighting in technology and health-care stocks. Less noticed by investors is the impact of almost fifty company removals over the last three years. These deletions were mostly of retail, industrial and energy companies, sectors that have happened to struggle the most in 2020.
A basket of the companies deleted from the S&P 500 over the past three years (for reasons other than acquisitions) is down 47% this year, almost five times more than the broad markets 2020 decline. Just five of the deleted firms have shown positive returns year to date. Bed Bath & Beyond and Macy’s, two large retailers are down around 70%.

Many of these companies were in some form of trouble before 2020, justifying their removal. But the fact that they belong to the industries that have struggled the most this year has been fortunate for anyone with passive index exposure to the market.

Changes in index members are made as needed and can be made at any time, according to S&P Dow Jones Indices. Human judgment is part of the process, the committee aims to minimize turnover and doesn’t view crossing below thresholds governing, market capitalization, as a reason alone to eject a stock.

The criteria for addition to an index are not the same as those for continued membership according to the S&P U.S. Indices Methodology rule book available on the Standard & Poors website. “An index constituent that appears to violate criteria for addition to that index is not necessarily going to be deleted unless its impairment is judged to be more permanent.

Removal of 30 companies would exceed the annual average over the last thirty years and be one of the busiest years on record. Even passive investments have active elements, a fact on display last month when an oil ETF reshuffled the mix of its futures in order to protect itself from blowing up.
A company must have a market-cap of at least $8.2 billion for S&P 500 consideration. Liquidity must also be sufficient, and the sum of total earnings over the past four quarters must be positive, along with profits in the most recent quarter.

Market-cap guidelines for the S&P500 were raised to $8.2 billion on Feb. 20, 2019, about a fifth of companies in the index no longer meet that standard today.

The index committee is probably hesitant to add more technology firms to a benchmark that’s already very concentrated in that sector. The Information Technology sector makes up 26% of the index, the highest share since the dot-com boom.

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