“Do I own SPCX?!” - Active Decisions Hiding in Passive Investments

Joe: Passive investing is often presented as a straightforward, you get what you see sort of strategy, where the only important considerations are tracking error and expense ratio. But as the historic IPO of a little company called SpaceX reminded us, passive investing isn't always as passive as it may appear at first glance.

That single event forced advisors and investors to wrestle with questions that they may not have even known they had to ask. Who decides what's included in an index? How do weighting schemes impact outcomes? What does it mean to own the market? And what happens if different indexes make different decisions?

In this episode, we're looking under the hood of passive investing and index methodology to uncover the active decisions hiding behind the passive label. Thanks for listening. This is Balanced PM.

Welcome to episode three of Balance PM, an XYPN podcast where we prioritize context over conviction to help you make better portfolio management decisions. We're your hosts, Joe Dunn and Andrew Almeida, coming to you from XYPN Sapphire. But before we get into it, I have a very special message from our chief compliance officer, and I can tell this one really comes from his heart.

This podcast is produced by XYPN Sapphire, an SEC-registered investment advisor that is wholly owned by XY Planning Network. We're part of the same XYPN family, so we may make references to the larger network. This content is intended for educational purposes only and should not be construed as investment advice.

All right, Andrew, we have an exciting topic for episode three, and I'm excited to get into it. And we're not gonna spend a lot of time focusing on SpaceX, but we're going to start the episode by discussing it because obviously there's been a lot of commotion lately around the SpaceX IPO and some of the index rule changes that have come with it.

To say the very least, I think people are excited, if not a little antsy about the SpaceX IPO. Am I right?

Andrew: Yeah, if you're following the World Cup like I am right now, SpaceX is, it's like Ronaldo. It's the big name out there, but do you really want it on the playing field? And I don't know. I'm taking a, I've taken more calls from advisors on this than I thought I might. Interesting topic, not without controversy.

Joe: Yeah, exactly. And so let's just kinda get into it. And like I said, we're not gonna dive into all of the nitty-gritty details of SpaceX, but it's really important to tee up our conversation by at least introducing what the conversation has been around SpaceX lately. And I think it's really important to start with the fact that this conversation is not about whether SpaceX is a good company or not.

That's not for us to say, and that's something that we'll learn over time. But rather, the conversation is more about the fact that we had the largest IPO in history, and millions of investors could end up owning the shares of an unprofitable company without knowing that was coming down the pipeline based on the investment decisions that they made leading up to that point.

And I think it's helpful if we kinda set the scene with a little context just to really highlight how momentous an initial public offering SpaceX really was. So if we're looking at the numbers, SpaceX came to market with just under a $2 trillion market cap, and it easily surpassed that $2 trillion market cap within the first day of trading.

And it also came after SpaceX raised over $85 billion in capital for this IPO So if we wanna add context to that, the prior largest global IPO was that of Saudi Aramco, Saudi oil provider. And that came to market with a roughly $1.7 trillion market cap and about 30 billion raised. And so SpaceX, we already see that they are at roughly the same market cap when it came to market, but just in terms of capital raised, nearly three times the amount of capital raised by Saudi Aramco.

And prior to Saudi Aramco in 2019 the prior largest American exchange IPO based on capital raised was in 2014, and that was Chinese tech company Alibaba, and that raised $22 billion for its initial public offering. And again, just to kinda round out this context, Saudi Aramco and Alibaba, those are not US companies.

Even though Alibaba s- traded and IPO'd on an American exchange, it is a Chinese company. And so if we're looking at purely US-based companies, the prior largest IPO in US company history by capital raised, it was in 2008, and that was Visa, which is pretty crazy to think that there have been more since then.

But yeah, that was the largest IPO by capital raised for a US company prior to SpaceX, and they raised $18 billion for that IPO. So SpaceX eclipsed that almost five times over. And it is helpful to note that there have been larger IPOs based on market cap alone, like Facebook in 2012. But for going based on the amount of capital raised, Visa 2008, that was the last biggest one.

So I think that really sets the stage with how momentous of an IPO this was for SpaceX.

Andrew: Yeah, that context is super important, Joe, because there have been larger IPOs, but the amount of capital you raise via the public markets is what you're going to market for, right? Nearly a 20-year gap before we eclipsed the $18 billion record of what Visa raised via the public markets to help grow your company And and offer your shares out to the public.

It had many people quietly asking and quiet rumblings, "Are US capital markets dead or dying?" And I think of this nearly 20-year period as like the secondary market period of buybacks and SPACs and, a lot to be said and controversy around SpaceX today. But, to some degree you could say, US capital markets are back, and this is a super large offering there, there is some positives there

Joe: And as if the numbers surrounding this IPO weren't big enough to really draw a big story, it's unprecedented. That's not where all the hubbub came from because it also comes right after Nasdaq modified their index inclusion rules for the Nasdaq-100 in order to accommodate the SpaceX IPO and get it included in the index sooner than it otherwise would've been.

And it's not just SpaceX. Obviously, we have some other big anticipated IPOs coming down the pipeline like Anthropic and OpenAI, and they're likely to benefit from these rule changes as well. But the timing was really poignant relative to the IPO of SpaceX. And so let's get into what those rule changes were and why people are talking about them so much.

And I think the first one that we wanna start with is the reduced seasoning period. So the seasoning period is just how long does a new stock have to trade on an exchange, or have to trade after going public before it's included in an index. And prior to this rule change, the Nasdaq-100 had a 90-day seasoning period.

So SpaceX would've had to wait about three months before it was included in the Nasdaq-100. But they changed that, so the seasoning period was actually reduced to only 15 days. So that's nearly two and a half months early. And so it kinda makes sense that, yeah, after an IPO, you don't know what direction it's gonna go in.

You wanna give it a little time to, to season, to set in, see how the dust settles before it gets included in these major indices. But that went out the window with this new 15-day period.

Andrew: Yeah, 15 days, might as well make it one day, might as well make it 15 minutes. They've really eliminated the concept of the seasoning period, and it's not just an arbitrary number of da- of days and time. There's meaning behind this and the reason for it is predominantly to weed out that post-IPO volatility.

Remember what we're doing here. We're bringing a company which was private to the public markets, right?

And there's a lot of rules around when you take a company public. Why? Because we want to have a fair offering and gain public trust. We're dealing with public markets now. So weeding out that IPO volatility and getting true price discovery is one of the reasons why you want a seasoning period that allows for some of this volatility to settle and the dust to settle.

The other reason you want it is for the lockup period. There's no rules around how long shares have to stay locked up. Traditional history is 180 days, and which has been used most frequently. And as insiders start selling their shares they could be dumping and putting pricing pressure on the public.

So there is a reason for having some time there and aligning what could be a seasoning period with lockup periods. On the other side of that, though, that's not to say that there isn't a period of time that isn't just too long. If you look pre-2012, the seasoning period by Nasdaq was two years, and this was a period that was different.

There were fewer passive indexed products and when you considered the advent of electronic trading and high-frequency trading, it just said, "Do you really need this long for price discovery?"

And you had a number of these larger hedge funds and active managers front-running what they would know to be almost certain index inclusion, thus getting in at lower prices before the public could in the indexed product.

So it's not just about time, it is also about structure.

Joe: Things are just moving a lot faster these days, and maybe this is just another sign of that, moving on to the next rule change, they eliminated the minimum 10% free float rule. And just to kinda lay the details of that out for everybody, free float rule, that's just referring to how much of the actual company's shares are traded publicly.

Because with SpaceX and other companies that go public, there are still shares that continue to be held privately by founders or original private owners and whatnot, and they don't just release those shares when the stock goes public. They hold onto those, and there's only a portion of the company that's actually traded freely, and that's the free float.

And originally, there was a 10% free float rule, so at least 10% of a company's shares had to be publicly traded in order to be included on the NASDAQ 100 index. And that got eliminated entirely, so there's no free float rule at all. And Elon Musk, he owns just under 50% of SpaceX shares still to this point, and that's along with other private investors.

So altogether, private owners have about 95% of SpaceX. So like in a lot of people's heads, that still seems like a pretty private company. Like, all of the major decisions aren't going to be made by shareholders that are holding those public shares. It's gonna be the 95% that's privately held.

And so when NASDAQ 100 eliminated that 10% free float rule, that just made the private ownership even more concentrated, and that made some investors not so happy because they want more of that free float out there in order to have more of the equity publicly exchanged.

Andrew: Yeah. This is important. We made a joke about eliminating the seasoning period to 15 minutes. They didn't joke about this, right? They just totally cut off the free float rules. And when I say they, I do mean the Nasdaq indices. And this does matter, right?

Traditionally, I think, I was looking at 30 years worth of data, companies within the range of when they go to public markets at the IPO offering anywhere from 10, which was the minimum on Nasdaq, up to 25% of the free of the shares to the public, right? So if you're offering 25% of the shares at the IPO, at the initial offer, that leaves, what?

75% of the shares to get unlocked over some period and additional selling into the market over, what was the traditional 180-day lockup And further out. And then, investors are forced to make a decision as well as insiders on price discovery through that period. Eliminating this now or with where SpaceX stands with, 5% of the total shares free floating, that means roughly 95% of the shares are still remain to be dumped on public markets.

So together with the time period, these two matter when married together very importantly.

Joe: And there is one additional detail with this modification of the free float rule is Nasdaq introdu- introduced this three times multiplier for companies that have less than 33 1/3% of their free float trading. And so that's saying that for, in this case, since it is definitely less than 33.3% free float of SpaceX that's trading they take the actual free float roughly 5% or so, and multiply that by three.

So that actually increases the weight in the index relative to what it would have previously been just under a standard free float weighted scheme. So it's a-- I guess it's a-- you could look at it positively or negatively because some people might have been concerned that Nasdaq-100 was just a pure market cap weighted index, and SpaceX was gonna come in here and represent a huge portion of it.

So luckily, that's not the case since Nasdaq is a, a modified cap weighted index, so they do adjust for free float and that, that brings in the exposure a little bit since there is such a small level of free float for SpaceX. But again, it's still more than it would have previously been represented under the prior Nasdaq-100 rules.

But I guess just if we can zoom out a little bit, kinda we talked about each of those rule changes, but in general what's your take on the rule changes and kind of the, the sentiment that investors should have around them?

Andrew: I don't like it. When it comes to Nasdaq and the rule changes, I don't like it, and it's because of what we're talking about here. When you take both seasoning period and free float into account and then the Nasdaq and a passive index who is going to be making now what is a mindless decision to buy, when you take those three together it is quite important.

And on the surface, the free float adjustment weight by the Nasdaq looks good, right? If you're looking at the, what is it? Invesco's ETF product QQQ Nasdaq 100 product, the weighting of SpaceX is about 1.25%. It was just added over this past week. And then, it's true, it's not gonna make or break your retirement, 1.25% of something you might have, 20% to 50% allocation to.

I don't know. It might differ for everyone, but it's not gonna break the bank. But what it-- what is happening here is potentially the erosion of some faith in the trust of the IPO process in capital markets because only 5% is free floating and these indices are already adding to it prior to any kind of out of price discovery, they're already buying and pushing up the price, right?

Now, consider that it is a free f- that the index weighting is free floating and the early release period associated with the s- the release of SpaceX shares. So Elon's locked up for a one year minimum, then there's some contingencies for him to release after a year. But the other roughly 45% to 50% of shares have an early release schedule that a majority of those will get released before the 180-day period.

So with that, together, knowing that these shares are up for early release, will get sold into the public, and the indices which are buying them must increase their weighting as the free float increases as those insiders dump the Nasdaq indices must buy more because the free float is going to increase, and they're free float adjusted.

So the free float will increase. They'll have to buy more directly as those insiders are selling. To me, this isn't price discovery. This is price taking, and I think that's where I have a beef with what happened with the Nasdaq and what's been structured here with the SpaceX IPO.

Not to say that other indices, though, didn't hold tight to their rules. We could talk about some of those later. But yeah. I'm not a big fan of it. On the w- on the other hand, though, just, as an aside, if I'm gonna play devil's advocate to myself, you do have our lo- one of our largest companies getting liquidity and our discussion about, coming to public markets and conf- and ability of, capital coming to US markets then yeah, this brings more capital to US markets, and that's a good thing, so

Joe: Yeah. When you lay it out like that, it does make me a little bit sour. But yeah, to your point, even though out of principle, not a huge fan. Out of actual impact on a well-diversified portfolio, it's gonna be in the margin, so it's nothing to lose sleep over. But for all of our listeners, tell us what you think in the comments.

Are you pissed or are you here for it? Let us know.

Andrew: Yeah. SpaceX is certainly stealing the headlines right now. For all my World Cup fans who are heavy into that it's kinda like Ronaldo, right? It's taking all the headlines, it's the star of the show, but a lot of controversy around putting it into the playing field right now, And that's what's happening with the indices.

Joe: So whether you approve or disapprove of the rule changes is beside the point because odds are, regardless of whether you do approve or disapprove, a decent portion of our listeners are in some way impacted by these rule changes or even beyond that, outside the Nasdaq rule changes, impacted by just the inclusion of SpaceX in one of the other indices that it will be included in.

So we just wanna run down a list of some of the major indices and products that will include SpaceX moving forward. Of course, the most notable one, which we've already touched on, is the Nasdaq-100, and that's definitely the most discussed one because it came with those rule changes. But outside of that, we also have FTSE Russell indices that are gonna include it.

That'll be the Russell 1000 and Russell 3000. It will not be included in the Russell 2000 Index because that is a small cap focused index. It'll also be included in the MSCI World indices, as well as a handful of broad total US stock market indices like the S&P Total Market Index, Dow Jones US Total Stock Market Index, and the CRSP US Total Stock Market Index, and CRSP is the Center for Research in Securities Prices.

Beyond the indices, obviously we have actual investment products that track those indices. So some of the major ETFs that will have SpaceX included moving forward are QQQ, which is Invesco's QQQ Trust, and that tracks the Nasdaq-100. And then we also have IWB and IWV, which are iShares Russell 1000 and 3000 ETFs respectively, and VTI, which is the Vanguard Total Stock Market ETF, and that tracks the CRSP index

Andrew: Yeah. That's quite the list. And takeaway certainly is know what you own, people. You have to know what you own. Here at XYPN internally we run two models predominantly used by our audience. A pure passive model which benchmarks to the MSCI All Cap World Index, but we use different products for each sub-asset class sleeve.

So on the US large cap equity side on our tracker model, we use VOO, which tracks the S&P 500, who has remained steadfast to their rule schema and will not include SpaceX. And then in our core model, which takes a more semi-active approach, we use VTI as the core total market holding, and then we look to pick up I guess you could say a little bit of alpha with some strategic over and under weights to other parts of the market, whether that be small cap emerging markets, international markets, or even in some instances a thematic approach as a small sleeve.

So that's what's being done here internally at XYPN.

Joe: Yeah. And of course, there's gonna be a handful of other products that will include SpaceX if they're themed accordingly any space themed products like ARKX or any, again, yeah, space and aerospace ETFs. But those aren't the ones we're worried about because that's more obvious

Andrew: XYZ astronaut ETF. Everyone's coming out with a product Now, just to buy it

Joe: Now, you can come up with a list of pros and cons for the inclusion of SpaceX and similar companies in indices. So it's not really a question of whether it's a good decision or a bad decision for each index, but it's more of a question of whether investors and advisors understand the composition of the indices that underpin a lot of the products that they use.

Do they understand that passive investments can change? Because I think a lot of people think passive investment it's gonna be what it is, and that's just, I can expect it to keep doing what it's doing the whole time. And do people understand how seemingly similar passive products can have some really important key differences when you actually look under the hood?

Andrew: Yeah, the conversation's getting more interesting as time goes on. I think most investors have traditionally thought passive investing means let me own, own a broad index and let me take out the human judgment from decision-making. But we're seeing that the truth is, passive doesn't necessarily mean that there are no active decisions.

It's just pushing those decisions upstream now, and there is some thought that needs to go behind it

Joe: Yeah, exactly. And to the point of pushing those decisions further upstream, we want to explore, all right, what those decisions are. And for the rest of this conversation, we want to frame it as a bit of a hypothetical thought experiment. So everybody gets into this mindset. So forget everything that you've been reading in recent articles.

Forget everything that you already know about existing passive investment products, the wide menu of passive investments that are out there. And as we go through this conversation, try to take a very clear mindset of if you had to build the US stock market, for example, from scratch into an investment product, which questions would you have to answer and how would you go about answering those very important questions that we're about to explore?

And the first question that we're going to explore is what should count? What should an index include? And so that's a conversation around inclusion methodology. Should it include every company? Should it include only profitable companies? Companies listed yesterday? Multinational companies? If it is a multinational company, does it matter how much of their business should be done in the US?

Should it include tiny micro-cap companies? If a company has multiple share classes, should they include both of those share classes? Should it include companies that are still mostly privately owned, like SpaceX? And there are no inherently correct answers to any of those questions, yet every single answer com- could change a portfolio in a meaningful way.

And none of those questions have answers that are actually neutral, and I think that's a, a key problem that a lot of investors think of passive investing as kind of market neutral. But again, all of these decisions are being made in passive products, and none of them are neutral. And obviously, I just rattled off a bunch of questions, and that barely scraped the surface.

So I think it's more helpful to kinda zoom out a little bit, at least for the purpose of this conversation, and think about these questions in more of a, a larger umbrella philosophical way and say, all right, what is the index's larger philosophy, and what's the story that their methodology is telling us?

Andrew: Yeah. I think actually those last few words you used are very important. What's the story the methodology is telling us? Because that is then what you need to tie to what your investment philosophy is going to be for your practice, for your clients, and following that philosophy. Because we can chop up and make an index any kind of ways, and these indices providers are becoming product providers running businesses to do just that.

But why are you using a particular index to achieve your client's goals is where I think everyone should start.

Joe: So let's dive into what some of those major philosophies could be. 'Cause again, we're not gonna dive into all of those many questions, so let's try to keep it zoomed out a little bit. And one of those philosophies for index inclusion might say, "Hey, the U.S. stock market should be represented by America's largest and most established businesses."

That's something along the lines of what the S&P 500 index might say for their inclusion rules. Another philosophy might say that the market should be represented by almost every single investable public company. That's more along the lines of what the Russell 3000 is aiming for. And then another philosophy might say, they might add a layer to that and say "The U.S.

stock market should be broadly represented with as many companies as you can include, but it should also be practical by reducing trading frictions and costs." And that's something more along the lines of our nerdy friends at CRSP. That's what they bake into their index methodology. And then, of course they address other questions like does profitability matter?

And S&P 500, they say, "Yes, profitability does matter. You must have four consecutive quarters of positive GAAP earnings in order to be included." Whereas Russell and CRSP, since they're just going for a broad market approach, they say, "No, profitability doesn't matter." They could be burning billions of dollars, and as long as they're large enough and liquid enough to be investable, then they're gonna get included in this index.

And there are numerous other underlying considerations that are too in the weeds for this episode. But it's just important to highlight that each index provider does things differently. And I think that at least from a technical standpoint, everybody can agree that there is some sort of correct definition of what the U.S.equity market is, and that would just be include literally everything. But that's just from a technical standpoint, and we know that it's not really feasible to capture everything in the real world when we're trying to build investable products. So keeping those practical limitations in mind Andrew, I kinda wanna get your take on is there a correct, quote unquote, way to represent the U.S. stock market, or do you think it's fine that each of these index providers is able to do their own thing and still be correct?

Andrew: Yeah. This is an interesting question because there is no, not necessarily a clear right or wrong a-answer here, and I think I might have my strong opinions on some of these things. First and foremost, if you're just making a benchmark comparison for performance purposes versus using what is philosophically supportive for you and your clients' values those could certainly be questions you're asking before you get into what is Right

from a technical perspective and a numerical perspective. But there's a lot of ways to chop it up And I've always been more of an S&P 500 person, but if I'm gonna be critical of that let's just pull out an example. We beat up on SpaceX a lot, but let's look at Uber, right? Uber went public in 2019. It's widely used by almost everyone across the country.

I can't think of anyone who hasn't taken an Uber at least once. They employ, when you consider the contract employees, if we weren't just looking at W2, they're one of the top 10 employers in the United States, but they were not in the S&P 500 for four years just based upon profitability, right?

I think their entrance was somewhere in 2023, a four-year gap between when they went public at, a size 70 to 80 billion in market cap that was large enough to be included, employing and being used widely across the United States, but not a measure of the market. Okay. Okay we can have our opinions about that.

So there's a lot of ways to chop it up. I think for me, just one of the more critical things that I would say is a, there's a, there's not a right way to do it, but there could be very wrong ways to do it, and I think there's one thing that I think you want-- And they all-- we haven't, we won't go into the depths of these, but liquidity for me, when you look across how Russell does it and FTSE and S&P and Nasdaq, there are some serious differences in terms of what they look at in terms of liquidity.

And for me, that goes to the conversation we spoke about with SpaceX earlier, with the free float and fairness in public markets. These are for-profit companies, these index providers who need to run a business, and they're doing it for profitability and offering a product, but I think they need to bear some responsibility on the trust in US public markets if they're going to represent the public market in their index, and I think that comes down to liquidity for public market participants.

Joe: And so yeah, if we look at all those index providers and they have different ways of doing things from an inclusion methodology standpoint, I think it's fair enough to say that there is no one correct way to do it. Whether obviously everyone has their opinions and not everyone's gonna agree with one way or the other, which comes back to it's just important to know what you own.

But yeah, we'll-- let's just leave it at, yep, there's no correct way to do it. Even if you disagree with some of their decisions, there's some reasonable way for them to explain it away, and it's hard to argue with their methodology at that point. But with that understanding that all these index providers do it at least slightly differently, what's your take on what does it actually mean to own the market today?

Because people might be owning one of those indices versus another. Different people will own different indices, and everyone will think that they're owning the market. So how does the topic of owning the market look in this context? And throw another wrinkle in there, talk about the inclusion of public versus private companies.

Obviously, private companies are part of the market, and to your point with Uber s- in a similar vein where it's a matter of economic impact versus inclusion in the stock market. Those aren't necessarily the same thing. So yeah what's your take on what it means to own the market today?

Andrew: Yeah, we discussed that you could just own the market in an all, all market index, but to me I cut the lines at the public and private conversation, and I think these public ETFs should only hold public companies because of the rules around public disclosures and our responsibility to maintain the confidence and trust in public markets.

And if you're including private companies in an ETF which is offered to the public, and they're held to different rules about disclosures and they're literally trading or valuations are based on the inside information exchange between them because they are private and they're allowed to do that privately and this, information and pitch decks and offerings through series A, B, C, D, right?

It all happens privately. I think you need to draw a distinction there between public and public public and private market investing. But all the semantics about chopping it up by market cap and or price weighting or free float and even the liquidities, as long as it's fair for public market participants I'm supportive of it

Joe: And the word semantics that you use there, I feel like it, it does come back to semantics because you can have all these different products, all these different indices that say total stock market, and we know that is just semantics because we know that they do not own the total stock market. And I think that introduces or brings us to an important concept, which is the proxy concept.

We know that all of these indices are just trying to represent the total stock market. They're not trying to be the total stock market because they know they just can't due to the, the practical limitations that we already mentioned. So all these indices put thems- themselves out there as a proxy for the stock market.

So even S&P 500 on the S&P's website, they reference the S&P 500 as a proxy of the US equity market, which you see that and then you s- also see that S&P has another index, which is the S&P Total Market Index that includes an additional 3,300 constituent companies. So it seems a little funny that you have the S&P 500 saying, "We're a proxy of the US equity market," and then also that same index provider puts out another product that adds 3,300 more companies and they say, "Oh this is actually our total market index."

And it's really important to understand that, yeah, these are just proxies and they, in this case with the S&P 500, the S&P 500 does track quite closely with the S&P Total Stock Market Index and the S&P 500 has actually tended to outperform slightly in most periods presumably due to the higher weights in mega cap companies which have really outperformed in recent periods.

So as of now, the S&P 500, its status as a US e- equity market proxy has held up pretty well but it's far from a neutral benchmark or a neutral representation of what the total US stock market is.

Andrew: Yeah, and a lot of this comes down to the evolution of what companies are succeeding, where people are acc- not just people, but companies are accumulating value, and how the market changes over time, right? The Dow used to be one of the most heavily quoted measurements of the market, pre-2000.

And I remember early in my career, people were s- were still quoting the Dow, and on the trading desk I worked at, some- a guy actually stood up and he just said, "Who's quoting the Dow right now?" Because he was, he thought it was ridiculous. And

Joe: we were still living in an industrial economy

Andrew: Yeah, so the economy's always going to change.

It's almost like a sentiment thing, an unspoken consensus of when everyone just starts looking at something else as the new measure of how we believe the market is best represented. And maybe we go from an S&P 500 to what becomes a, a new Dow 30 or Dow 50 or name your provider and the number of stocks, because our economy entirely shifts to one that is driven on AI and power and less so on retail and and software, Right

As the economy evolves and changes, so will the way we measure it. And, being hard and steadfast to one measurement as your index or provider, being loyal to a provider is certainly not the approach I think anyone should take. But understanding how they evolve and then just bringing this all back to the client, if you have $100,000 today and you need to get to a million dollars 10 years from now, your benchmark is that rate of return.

It's not what the S&P 500 is doing. So I would love to just bring the conversation just a little bit there back to the client, because the semantics of these are less important than what you're trying to achieve for your client, picking a philosophy, and then press and start.

Joe: Yeah. And what are your thoughts on, so specifically in this S&P example, like we have the S&P 500, which says it's a proxy for the US equity market, and then we have the S&P Total Stock Market Index, which has thousands more companies. So what's your take on the ability for the S&P 500 to be an accurate representation of the market when it's missing such a huge chunk of the actual underlying companies?

Andrew: Look if you're gauging it based upon performance, which I think most of us are, or how do I hold the market and get that exposure, then Yeah. you should be indifferent about the companies which aren't making up a lot of the performance exposure because they're what?

They're simply just not contributing to the accumulation of value inside of the economy. So if your re- reward to volatility profile is similar by holding 50 companies or 500 companies or 3,000 companies then, you should be indifferent to them as well mathematically

Joe: And from a diversification standpoint, there is statistically a diminishing marginal return to that diversification benefit as you start adding more companies. So yeah, obviously if you have 10 companies and you bump that up to 500, then that's gonna be a notable benefit to diversification.

But f- beyond 500, w- what does an extra 3,000 do at that point if statistically it's not going to lead to a dramatically different outcome?

Andrew: Yeah, and I could nerd out on the, the portfolio volatility equation, but somewhere after 30 names and certainly after 50, even if you're adding a company which has, 10X the volatility at the same weight of, let's say, the, the highest weight, highest or median weighting of that index, let's say the median weighting of that index, you're not really gonna change the overall volatility of the portfolio.

There's de- diminishing utility of adding another company for diversification purposes after you get out, past 30 names And certainly past 50.

Joe: And just to round out this inclusion section, I think it's just also important to note that, we're discussing these questions mainly in the context of a broad U.S. equity market index, but these decisions do tend to become more noticeable and maybe more consequential as you get into more esoteric areas of the market or just more specific areas.

If you were to zero in on small cap maybe the, the inclusion rules will be a little bit more impactful or international. There's there's a, a wider range of questions that have to get answered once you start getting into these smaller areas of the market

Andrew: Yeah, for certainly. And if it's from a US investor's perspective, again, it kinda comes back to in- investing in an international or foreign index. You see it even be more common of a theme to say, "We're doing XYZ with the index to protect US investors." And that goes back to my whole conversation about protecting the integrity of public markets and investors' trust in the public markets

Joe: Now that we got through the question of what gets included, the inclusion methodology, let's move on to the next question, which would be how much of each company should be included in the index?

How much does each company deserve to be represented? And to keep this thought experiment going, let's imagine two indices. They agree on all of the inclusion details that we just discussed, and they agree on the same constituent companies. But they choose different weights for each of those companies, different levels of representation.

Nothing changed but their weighting philosophy. But all of a sudden, you have different concentrations, different returns, and different risk profiles. Agree on all the same companies, different weightings, and that can change everything

Andrew: Yeah, Luckily we have some real-life examples to go through because there are real companies faced with making these decisions. Thankfully it's not us.

Joe: Yeah, exactly. And the most popular weighting scheme that we see, S&P 500 is probably the most referenced index in the US, and they use a market cap weighting. So let's just talk about what is the overall philosophy behind market cap weighting. And that's that the market decides how important each company is.

And that might lead people to decide, all right-- or to, to ask why should a company have larger percentage of representation in a portfolio simply because its price doubled or tripled or just went up in general? Why should a price increase justify a higher degree of representation? And so let's go through some of the pros and cons of what a market weighting index would bring us.

On the pros side, first is that it's self-adjusting, which is really helpful. So the weights of each constituent company in a market cap weighted index automatically adjusts as the market caps change. Price price goes up, say without changing any of the outstanding share quantities.

Price goes up, market cap goes up, the representation in the index automatically goes up because the company is worth more. They still hold the same number of shares in the underlying index, so its representation moves proportionally as it should. And this is helpful because it leads to lower turnover.

They don't have to make as many trades to adjust the weights of the underlying companies. And with lower turnover, less trading, that leads to lower transaction costs, and it ends up being a lot more tax efficient for the end investors. It also is helpful because in many environments, at least based on recent history, we know we can't rely on that for future results, but in many recent environments, it helps where the winners keep on winning.

And as companies keep doing better and their market caps go up, then they become a higher percentage of the underlying index. So if a company keeps winning, then yeah, you'd want it to keep representing more of your portfolio because then that means you keep winning more as well. But also important to note that kind of relies on the efficiency of the markets and ensuring that these companies that are winning from a price perspective are actually winning for the correct reasons and not just some irrational exuberance that's driving up the price.

Andrew: Joe, the-- sneaking that last point in there, I didn't initially see that when we went through the dry run of this, but that is super important. These are very efficient indices and I, and many people favor them because they represent the true accumulation of value of the companies that are publicly traded.

But you have to agree on efficient markets. You have to agree that this accumulation of value is represented by an efficient market where public market pricing can be trusted because all participants are agreeing on that value of that company. Thus, that is how things are truly represented and you can rely on it.

So really good point there

Joe: Yeah, and then the last pro I'll mention is just from a liquidity standpoint. It avoids any mismatches between the size of the position in the index and the actual company's liquidity because obviously the index has to own more of the largest companies, and luckily the largest companies tend to be the most liquid with smaller companies being less liquid.

So that helps mitigate any issues that you might run into in terms of a mismatch between the size of the representation and how much you have to buy and the amount of liquidity that supports that level of purchasing. But with that out of the way Andrew, take us through what are some of the cons that come with a market cap weighted index?

Andrew: Yeah. I guess the cons if first, if you think that maybe pricing is inefficient, then you're gonna end up with some concentration risk as the winners keep on winning and accumulating value up the chain. If you disagree with efficient markets, then you have concentration in what could be overvalued companies.

And interestingly enough, many people are asking themselves that very question today. I spoke with an advisor last week who said, "I don't think it makes sense to own these top 10 companies at these PE ratios," right? So they might take a more value-oriented approach or find a s- a philosophy that's right for them.

And then it could have a momentum bias. Does the momentum factor continue to favor and this period and kind of accumulation of value that we've seen over the last decade does... Is it a true representation of the market And does it continue on?

Joe: And with that momentum bias, it ends up leading to a pretty I wouldn't say unconventional, but it goes against what you would think is common sense from a, a trading strategy because with momentum or generally the rule of thumb is you wanna buy low and sell high when you're investing over the long term.

But with a momentum bias, it actually tends to lead to buying high and selling low when it comes to the composition of the index. And that's not on a regular daily trading basis. I'm talking about when we actually see some shifts in the underlying composition of the index. And I kinda wanna zero in on that with a little bit of a case study that actually happened in real life.

If we take ourselves back to 2020, and I'm sorry for anyone who does not wanna go back to 2020, but we're just gonna do it for this thought experiment. S&P 500 had a reconstitution in 2020 where they made a pretty newsworthy change in the stocks that were represented. We have Tesla and AIV, which is Apartment Investment and Management Company.

These are the two companies that we're thinking of right now. And prior to this reconstitution in 2020, AIV was held in the S&P 500 and Tesla was not held in the S&P 500. But as you can tell, this reconstitution changed that where they flip-flopped and said, "All right, we're gonna include Tesla in the index and we're gonna take AIV out of the index."

And there's an interesting dynamic that leads up to one of these reconstitutions, and that's pre-inclusion and pre-exclusion buying and selling. So we know that trading activity can impact prices. If people are constantly buying a stock, that's gonna drive the price up and lead to a higher price.

And conversely, if there's a large amount of people selling a stock, then that's gonna drive the price down. And of course, when a stock is being added to an index in the future that's gonna lead to a lot of buying just to get it into the in- the products that track this index and say, "All right S&P 500 is gonna include Tesla moving forward," so these products are gonna have to buy it and naturally that buying is gonna be supportive of Tesla's price.

And same thing on the opposite side with AIV. If it's gonna get excluded from an index, then it's gonna be sold out of all these products and that's gonna lead to downward pressure. And a lot of people try to get out ahead of these index changes. They try to front run these index changes and that leads to pre-inclusion buying and selling.

And that gets you to a point where, all right, by the time that Tesla got included in S&P 500, its price was already inflated relative to where it was not long ago. And same thing with AIV, where by the time they have to actually take it out of the index, price is lower than where it was before the reconstitution decision was made.

And if we're looking at this specific case of Tesla and AIV, six months in after this 2020 reconstitution, AIV was outperforming Tesla by roughly 60%. And nobody who was invested in the S&P index was able to benefit from that because AIV wasn't in the index anymore. And two years into this, AIV had outperformed Tesla by roughly 90%.

So that's, it seems to be some pretty noteworthy price movement after the fact that the S&P 500 investors didn't get to enjoy in just because, all right, Tesla's price got driven up above maybe where fair market value should be, and then it came back down after people were already invested in it in the S&P 500.

So that's where I mentioned the buy high, sell low dynamic, where, yeah, they sold AIV low because of the pre-exclusion selling, and then AIV rebounded notably after the fact. And same thing with Tesla on the other side, where the S&P 500 index and the products that track that were forced to buy Tesla at a higher price than maybe fair market value would have originally dictated.

And then Tesla underperformed in some notable time periods after the fact. And they did flip-flop back and forth a few times, and now it's safe to say Tesla is very thoroughly on top by with more than 100% outperformance since that reconstitution. So in the long term it worked out fine and Tesla outperformed AIV, but that doesn't mitigate the very real impact that this trading dynamic had in the near term following this reconstitution.

Andrew: Yeah, certainly you're always gonna have the speculators and the hedge funds and HFTs, you know, doing index arb and even others trying to speculate and get ahead of these things which could distort price. Funny enough what, it took Tesla something like 10 years to get into the S&P 500 and index inclusion's almost like a lottery ticket.

But if someone already has the answer to when you can select that lottery ticket a lot of distortion can happen in the near term. You would expect fair values to get recognized over the long term, but at the end of the day you want your equity included in an index 'cause it just means more buyers and it…

I think the takeaway is more that index-based investing has changed the market structure and the more index-based passive investing and to some degree handing over the thought and decision-making process behind investing has created, we talk about a K-shaped economy, but a K-shaped market where there are fewer and fewer participants making active decisions over price while other people are just being price takers if, if that if I can pull one takeaway out of that.

Joe: Yeah, but all of that said, it's very clear that there are pros and cons to a market-weighted index, and again, it comes back to personal preference maybe and whether you like that trade-off. But let's move on to the next weighting scheme, which would be equal weighting. And the philosophy behind equal weighting would be that every company should be equally represented.

This is the people's weighting scheme. We got real democracy going on here where each company gets the same say in how the index actually performs. And S&P 500 has an equal weight index that we can use as a, a good comparison for the regular market cap weighted S&P 500. But focusing on the equal weight, for the pros we have, all right we said for market cap weighted that it can lead to excess concentration in those largest companies.

The other side of that is the pro for equal weighting is that it helps mitigate that concentration risk. In the case of the S&P 500 the cap-weighted index, the top 10 companies represent roughly 40% of the index. All right, and if we move over to the S&P equal weight, which again, is the same exact 500 companies that represent that index, but they're represented at equal weights, that brings the top 10 companies down from 40% all the way down to 2%.

So that's a pretty noticeable difference. Again, from a performance standpoint it could end up going well or poorly. In recent history, we've seen that equal weight has underperformed. But if your goal is to mitigate concentration risk, then yeah, equal weight will help mitigate that concentration risk and in general just increase your divers- general diversification benefits.

And another pro of equal weighting is just the flip side of the, what we were just talking about with cap weighted is the trading dynamic. And with equal weighted, it does have a buy low, sell high trading dynamic, which makes sense to a lot of people. And that's because, all right, if they're equal weighted, say every company, they want to be represented at 0.2% of the entire index.

If their price goes up, then they're gonna be weighted more heavily, so the index is gonna have to sell down that position to bring it back down to the standard 0.2% weighting. So when the price goes up, then that prompts selling which again, that's the buy, buy low, sell high dynamic, which to a lot of investors, that, that makes sense.

But on the con side, that obviously leads to a lot of turnover. If you're trying to stick to a fixed percentage representation for each of these companies and their prices and market caps are, or their prices are changing on a daily basis through- throughout the day, then that's gonna lead to a much higher degree of turnover.

You're gonna have to trade to get them back to those target weights, and that ends up being less cost and tax efficient for the end investor. And another con is it just, a lot of times it leads to you're forced to sell the biggest winners. Again, like the, the top 10 companies represent 40% of the S&P 500 and they've kept winning and that's been helpful for investors.

They would've foregone a lot of that positive performance if they were forced to sell and keep those big players at a smaller weight. So again, equal weighting, pros and cons to to equal weighting versus cap weighting, and a lot of it comes down to what your expectations are

Andrew: Yeah, I think equal weighting's one I think I, I have a little bit more strong opinions about, And not just because of the relative performance in recent years, more so in relation to how we measure economic activity, right? If we think about h- you know, the purpose of an index to measure the broad value of our capital stock of the equity market stock in our country, let's relate that to GDP, total value of goods and services produced by an economy.

Let's relate that to inflation, how the value of those goods and services have increased in aggregate. Let's relate that to the capital stock, the total value of how our capital stock has increased. To equally weight is to make an active decision. So for me, this is just a, this is a product that was invented to have another product on the shelf for these index companies and then try to appeal to someone's philosophy as opposed to saying that this is a broad measure of the US stock market.

Not to say that there's not a place for it and if people feel like that's their philosophy for portfolios it's just not one that I think is a good representation of an index.

Joe: And we keep referencing performance in recent periods, but let's put some numbers to that so people get a sense of, all right you're saying there are pros and cons for both, but cap-weighted has definitely outperformed when I've been paying attention in recent periods. So has that always been the case?

And the answer is no, has not always been the case. If we're looking at just returns, let's-- and as an example, we're gonna use the S&P 500 Total Return Index, which is cap-weighted, and the S&P 500 Equal Weighted Total Return Index, which is of course equal-weighted. And from a return standpoint if we're looking over a longer time horizon, go back to January 1st of 1990, and we're bringing us all the way through the end of June of 2026, the equal-weighted index actually outperforms the cap-weighted index by roughly 580% over that period.

So on an annualized basis, that's the equal weight outperforming by about 5.4% annualized or so. That's 1990 to modern day. But if we're looking over more recent time periods, whether it's from 2010 or 2024 to now, cap-weighted has notably outperformed. January 1st of 2010 through the end of June 2026, cap-weighted S&P 500 outperforms by about 171% and that's about 6.25% annualized.

So yeah, as, as we've gotten closer to where we are now in history and we've seen the narrative or the, the trend of mega cap outperformance, the cap-weighted index has outperformed. But if we're looking over a longer time period, if somebody started investing in 1990 then equal weight would've given them pretty notable outperformance, which is interesting to keep in mind.

But beyond pure performance, just a return perspective, we also need to take risk into consideration. And if we're looking on a risk-adjusted return basis and referencing, say, the Sortino ratio for this purpose, whether it's 1990 to now, 2010 to now, or 2024 to now, the cap-weighted S&P 500 has outperformed on a risk-adjusted basis in all of those periods.

So even when equal weight outperformed on an absolute basis, cap-weighted still outperformed on a risk-adjusted return basis, and that speaks to the higher volatility of smaller companies and the presumably lower volatility of the larger companies that are in there.

Andrew: Yeah, I think it goes without saying that the smaller companies are gonna be more volatile than the higher than the larger companies. But I think it is important not just important, let me say it this way, you have to include risk in your assessment because if when you start getting into the conversation of investment selection, we talked a lot about how you can broadly just make an index, but if we start to think about decision-making, at least the way I philosophically think, you can't exclude risk.

It's the, the two come hand in hand. It's ice cream with the cone that

Joe: Should actually start with risk

Andrew: Yeah, you gotta start with risk. And the return conversation, you could always move the goalposts to find better periods of outperformance for any strategy. But when you include risk, that picture gets a lot more clear

Joe: Yeah, absolutely.

So let's move on to the final weighting scheme that we're gonna discuss, and that is fundamental weighting. And the philosophy behind that is that the actual underlying performance and economics of the business itself is what should dictate how much representation a company gets within an index.

So we're not relying on what the market says based on price performance. We're saying, "All right, what is the actual business doing? How is it contributing economically? What are the fundamentals?" That's what dictates how much we should weight it. And that sounds pretty reasonable at face value, at least.

So let's look at some of the pros of that. And one of the pros is that it does mitigate overvaluation concentration risk. You still could find yourself with some concentrated positions, but if that's the case, then you know it's because the underlying business, the underlying fundamentals are strong and supportive.

You're not gonna get to a point where you're over-concentrated just because of the market driving up the prices. And this leads to at least perceived better economic representation. It comes back to what we were saying earlier about the difference between the stock market and the actual economy.

And same thing here, where it's trying to get a better representation of the actual economy within its representation of the stock market. But on the con side, taking this approach is, it's essentially a value tilt. It's really t- finding the securities that have reasonable prices based off of their underlying fundamentals, which is a value strategy.

And while it makes sense from a logical standpoint, we've seen long periods of time where the value tilt does tend to underperform. So that is a potential concern with a fundamental weighting scheme. And on top of that, another con is that you'd probably see notably higher turnover. I'd be curious to see if there's a way that they mitigate turnover in situations like this, but at least in theory, I'd think that the underlying economic footprints of these companies are changing every quarter as a new earnings report comes out.

So they're gonna be adjusting their, the underlying weights of each of those companies, and that could lead to more trading, higher turnover, and leading to higher trading costs and taxes for the end investor

Andrew: Yeah. Interesting one here, Joe, because fundamental weighting I think really now starts to push us out to the boundary of where we can, where we go from saying something is a passive index to a rules-based index, and now you're making active decisions. So there are ways to build indices, and then there's the conversation of passive versus active.

You get into fundamental weighting, you do have some active philosophy that you cannot ignore that you're saying is a way to look at the markets. And then second, just to provide a little bit of a counterpoint or play devil's advocate with mitigating overvaluation and concentration because there's some fundamental representation of how this company is doing, it's all based off old data.

It's all based on historical data, right?

The counterpoint of that to a market or of a, a market cap weighted index is that price is the best indication of value because pricing is discounting future expectations, right? So you are taking also two different ways of looking at the market, saying, "I do believe in price efficiency," versus, "I'm gonna take historical data," which can change tomorrow based on if a CEO is fired, has a scandal passes away, any number of things, and then you could have over-concentration to something for other reasons.

So just something to keep in mind when you think about some of these other rules-based indices.

Joe: Absolutely. But general moral of the story is, again, even if an index or multiple indices agree on every single company that should be represented within the index, there's a range of weighting schemes that they can use that can dramatically change the actual performance of that index, even if the underlying companies are exactly the same.

Andrew: Yeah, for sure.

Joe: All right, so this brings us to the third and final major component of our conversation. We-- at this point, we've already decided on our philosophies around what should be included and how much should be included. But after those decisions are made, there's still an important decision of, all right, how do we go about making decisions on how these indices are adjusted on an ongoing basis?

And one of the ways to do that is with a human committee. In the S&P 500, that's a very common example that uses a human committee. But picture this. Somewhere, sitting around a table, there's a committee of people, and they're making important decisions about whether one company represents the U.S. stock market better than another.

The rules-- They have rules in place that get them most of the way there in terms of their inclusion rules, as we discussed. But you're gonna get to the end of that list of rules, and there might be multiple candidates that all meet those requirements, and then it comes to a human that has to use their discretion to decide, all right, which one of these do we think is a better representation of what the U.S. stock market should be through our S&P lens? And that can be a pretty impactful decision, not only for the investors in these indices, because they're deciding, all right, which company are you gonna be invested in, but also for the companies themselves. Because for the companies on the edge of this decision, it can-- i-index inclusion or exclusion can have a really huge impact on their prices and their equity valuations because of what we were talking about before with the forced buying and selling.

If you have two companies that are, like, neck and neck for, ooh, they, they're both really good representations of what the U.S. stock market is, but we're gonna go with this one, then that one's gonna be forced to be purchased by indexes and the products that track that index, and that's gonna drive up the price.

And conversely, for the stock that doesn't get included, they're not gonna get that pro- positive price action, and that's gonna lead to them not realizing valuation gains like the other company that got included, and that can have real long-term impacts on the actual viability of that company.

So kinda take us through, with all that in mind, what are the pros and what are the cons of having a human committee involved in this part of the decision process?

Andrew: Yeah, there's certainly both pros and cons to the human element of deciding how to make up an index, not just who's included, but what is the playing field, what are the rules for our index, and then when do we change them? Certainly the benefits are having experienced people who've seen multiple markets or market environments and having the context around when something may be at the fringe or the metrics aren't as representing the strength that you would like to see.

And I think the other thing that speaks to the experience of having a human element is the flexibility to maybe update those rules in a favorable way as markets change. So we discussed that earlier, right? The Dow 30 used to be something we looked at, and that's changed over time. If you could make those mo- modern adjustments to your index, so as long as they're favorable and consistent with market conditions, I think a human element could be a good thing.

But then it could be a bad thing, right?

Humans come with biases. They come with political influence or even influence from CEOs, right? About, "Hey, push my company into the index." So I don't think you could take those away from the human element. And then just, human error, thought process, people coming to agreement around a committee and a table, could hinder or result in a decision that favors one company over another, and maybe they make the wrong decision.

Joe: Yeah, it's a bit of a black box at a certain point because, even if the committee makes a good effort to explain their thought process, like you don't actually know unless you're inside their heads. And to your point about the potential political impact, even outside of strict politics, there's just, there's probably a lot of people at this point in their career, like industry professionals.

So whether you're a CEO of a major company or you're on the committee of the S&P 500, you're in the same ecospheres at certain points in time. There's a lot of overlapping circles and whatnot, overlapping influence that investors might not have a clear line of sight into. And so yeah, it is just an opaque piece of the process that leaves a lot of transparency to be wanted, I'd say.

Andrew: hand it over to the AI yet.

Joe: Yeah, exactly. But on the other side of that, other than a human-based committee, we have some indices that take a strictly rules-based approach. And again, everything comes with its pros and cons. And if we're using a strictly rules-based approach and trying to take out that degree of human judgment that comes with a human committee, on the pros side, we have that it is very consistent and transparent.

You see these rules and you know how they're going to be followed. So the, the roadmap is there and you know exactly what it's gonna get you. So that's one positive piece. But to your point where you were saying about the human committee, one of the pros is that they have the ability to adjust and pick up on some of the nuance that a strictly rules-based approach wouldn't gather.

That's where we come to for a con of a strictly rules-based approach is that there's little room for nuance and it's less flexible. So if, say, the economy or the market changes in a very meaningful way that an existing set of rules does not capture, then that could be a negative because it's not going to be able to adapt to the times, at least in real time.

And even with rules-based indices, it's not super cut and dry because again, Nasdaq-100 yeah, there is, there's a human component of that even when it comes to the rules piece of it. There were rules in place and then they moved the goalposts, like they, they adjusted those rules.

And even if that's not the case, there's still human influence because who created those rules?

Unless, to your point, they end up bringing AI into the mix at some point which would be a dangerous game. Even if you're going based on a strictly rules-based approach, there is still human influence that you're just further detached from because the human influence came at the time of the index creation and the rules were being created.

Even if they don't have their thumb on the scale on an ongoing basis, they still had a very real impact on the formulation of those rules. And yeah, I think this, this whole conversation is really about just knowing that there are pros and cons to all of these things. Strictly rules-based, it's not right, it's not wrong.

Human committee, it's not right, it's not wrong. It's just a matter of knowing, again, what are you investing in and what are the potential implications of the underlying rules?

Andrew: Yeah. I think this was a great conversation, Joe. We really took some great anecdotal examples, both old and current, like SpaceX. We w- we went into the weeds of index methodology, which I don't know that everyone does every day, so I hope everyone gets a good takeaway from some of the details that came out in this podcast and this episode.

Big picture: know what you own. Don't shy away from going to read through an index prospectus Or a product prospectus and understanding the index rules tied to it. Can't tell you how many times I've read through Dow Jones Dividend 100 and Dow Jones Dividend Select 100, and they're different.

So get in-- you have to get into the weeds of those sometimes. Passive is not entire... It doesn't mean you don't, you're not making a decision. You are. So I hope someone is.

Yeah. But you should know what decisions they've made. If there's anything to this, not everything's 100% passive.

Joe: And don't wait for a major story like SpaceX to really drill into these questions. It's something that and this is where advisors come in handy, because obviously we don't expect individual investors to really be thinking at this level all the time. That's why we're here. That's why financial advisors are here.

It's important to keep these things in consideration even when they're not s- splashing across your headlines every day.

Andrew: Yeah. Nice work on this one. Well done, Joe. Thanks for getting into the weeds

Joe: same to you. And let's just leave our listeners with a little bit of a nice wrapped up conclusion. So we'll leave you all with this. Ultimately, the biggest takeaway from our discussion is that passive investing doesn't actually remove active decisions. It just pushes them further upstream. Whether it's deciding exactly what an index is targeting, which companies get to represent that slice of the market, how much weight each constituent should carry, or how these ongoing methodology decisions are made.

There are always consequential, non-neutral decisions that are being made somewhere in the process. That's why evaluating passive products should go well beyond the common review of expense ratios and tracking error. You need to dive deeper and truly understand the underlying philosophy. Ask yourself, "Does this index's methodology actually align with how I want my money allocated?"

And there is no single correct way to approach these questions. The goal isn't to necessarily find the perfect index, but rather to be fully aware of the structural differences and design choices that are so often obscured by the passive label. Thanks for joining us for episode three. This is Balance PM.