An equity index is a basket of stocks aggregated by a defined formula to track the performance of a market, sector, or factor. Indices were originally tools for measuring market performance; they have become the dominant frame through which capital flows into equities, with passive index funds and ETFs holding several trillion dollars of assets globally.
Major indices
- S&P 500: 500 of the largest US companies, market-cap weighted, free-float adjusted. The dominant US benchmark — approximately USD 50T in assets benchmarked to it.
- Dow Jones Industrial Average: 30 large US companies, price-weighted (an oddity). Mostly retained for historical reasons; less used by institutions.
- NASDAQ-100: 100 largest non-financial NASDAQ-listed companies. Tech-heavy proxy.
- FTSE 100: 100 largest UK-listed companies, market-cap weighted.
- Nikkei 225: 225 large Japanese companies, price-weighted.
- MSCI ACWI (All Country World Index): global benchmark covering ~85% of global equity market cap across 23 developed and 24 emerging markets.
- MSCI Emerging Markets Index: 24 EM countries, the principal benchmark for EM equity funds.
- JSE FTSE All-Share / FTSE/JSE Top 40: the principal South African benchmarks.
- NSE 20 / NSE All-Share / NSE 25: Nairobi indices, with NSE 25 the most representative for institutional benchmarking.
How an index is constructed
The S&P 500 is constructed by an index committee that selects companies based on market cap (currently roughly USD 18B+ minimum), liquidity, profitability (positive earnings in recent quarters), and float (sufficient public ownership). Companies are weighted by their market capitalisation adjusted for free float (excluding closely-held shares). Apple, Microsoft, NVIDIA, Alphabet, Amazon, Meta, Tesla — the so-called Magnificent Seven — collectively account for over 30% of the S&P 500's weight. This concentration is the highest it has been since the early 1970s.
Indices are rebalanced periodically. The S&P 500 has quarterly committee reviews. Russell indices rebalance once a year in June. MSCI rebalances quarterly. Each rebalance triggers index-fund buying and selling — predictable enough that specialist 'index-arb' trading strategies have existed since the 1980s.
The index inclusion / deletion effect
When a stock is added to a major index, passive index funds must buy it. Studies have documented a 2-7% price pop on the day of S&P 500 addition, with some of the move reversing in the following weeks. Similarly, deletions produce a price drop. Recent research suggests the effect has weakened as the size of the passive ownership has grown and active managers anticipate the moves. Tesla's 2020 addition to the S&P 500 — a USD 80B inclusion event — was a notable test case.
The structural shift to passive
In 2009 passive equity funds held approximately 18% of US fund assets. By 2024 the figure had crossed 50% of US equity mutual fund and ETF assets — meaning that, for the first time in modern history, most US equity assets were in funds that don't try to pick stocks. Globally the picture is similar though less extreme. The shift reflects: persistently disappointing active-manager performance after fees, declining costs of indexing (some ETF expense ratios are below 0.05%), and increasingly sophisticated index design.
The major index providers
Index licensing is a high-margin business dominated by three providers: S&P Dow Jones Indices, MSCI, and FTSE Russell. Each charges asset managers running passive funds a basis-point fee based on assets benchmarked to the provider's indices. Vanguard, BlackRock (iShares), State Street (SPDR), and Invesco are the largest ETF sponsors globally, collectively managing several trillion dollars of indexed assets.
The 'passive is too big' debate
As passive ownership has grown, concerns have emerged about: (1) price discovery if too few investors are actively assessing fundamentals; (2) governance impact when major index funds collectively hold 20%+ of large companies and rarely vote against management; (3) systemic-stability implications if redemption shocks force concurrent ETF selling. The empirical evidence on these concerns is mixed, but the debate has become a regular feature of the market-structure discussion.
The Jack Bogle case
Vanguard founder Jack Bogle's 1976 launch of the first retail index fund was met with widespread industry derision. Active managers called it 'un-American' to settle for average. Five decades later, Vanguard manages over USD 10 trillion. The empirical case Bogle made — that on average, after fees, low-cost passive beats most actives — has been borne out by SPIVA scorecard data updated yearly.
Reading the SPIVA scorecard
S&P publishes the SPIVA Scorecard semi-annually, tracking active-manager performance vs benchmark across categories and horizons. The consistent finding: most actively-managed equity funds underperform their benchmarks over 5- and 10-year horizons. Persistence of outperformance is weak; today's winners are not reliably tomorrow's winners.
Exercise
A stock is added to the S&P 500. Its market cap is USD 30B. Roughly how much purchase demand is generated from passive funds tracking the index?