Courtesy Everett Collection
The strongest support for the merits of active management may have been staring Wall Street plainly in the face for more than a century.
The Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.08% , which many view as synonymous with stock performance, has accomplished a remarkable feat since its inception in 1896: The blue-chip gauge has beaten the overall market, as measured by the S&P 500 index /zigman2/quotes/210599714/realtime SPX -0.39% , for long stretches of time.
Statistically speaking, this is basically unprecedented. Data have repeatedly shown that active management, especially over the long term, cannot compare with passive in terms of returns.
Whether the Dow industrials are actually active is debatable. But before critics argue that the Dow is merely a benchmark of 30 stocks intended to offer a passive snapshot of the market, consider that the 120-year-old gauge has many of the hallmarks of what’s typically perceived as an active fund.
Its components are handpicked, rather than being set using a rules-based process or some other kind of formula, as is the case with passive indexes. Specifically, membership is determined by a committee that includes editors of The Wall Street Journal . The Journal and MarketWatch are both units of Dow Jones, owned by News Corp. /zigman2/quotes/201755982/composite NWSA -1.18% .
Inclusions in the Dow aren’t based on market capitalization, at least not entirely. And uniquely among closely followed benchmarks, it is price-weighted, meaning the most expensive stocks, regardless of overall market cap, have the biggest influence on the direction of the index.
What this means is that a big price move in Goldman Sachs Group Inc. /zigman2/quotes/209237603/composite GS -1.16% , which trades around $240 a share and has a market cap of about $90 billion, has a bigger impact on the Dow than an equivalent percentage move in Apple Inc. /zigman2/quotes/202934861/composite AAPL -1.07% , which trades near $116 but is the largest public company on the planet, with a market cap of more than $600 billion.
That is why Goldman, which recently surged on the hope of looser financial-sector regulation under President-elect Donald Trump, has accounted for a sizable part of the gains since the election.
David Blitzer, the chairman and a managing director at S&P Dow Jones Indices, who heads the committee that determines what companies are added to the index, laughed when asked if the Dow should be viewed as an active instead of passive vehicle. Then he conceded the following: “It is more actively managed than any other index I can think of—ours or anyone else’s.”
Other indexes simply comprise the largest companies in a coverage universe (for example, the 500 biggest companies for the S&P 500), with periodic rebalancing to account for names that fail to meet its criteria.
The Dow’s committee has guidelines for selections: Holdings must be incorporated in the U.S., are required to be components of the S&P 500, and transportation /zigman2/quotes/210598063/delayed DJT -0.84% and utility companies /zigman2/quotes/210598062/delayed DJU +0.11% aren’t allowed, as there are separate Dow indexes dedicated to those sectors.
“Beyond that, we have a good deal of discretion when it comes to narrowing the list down,” Blitzer said of the committee. “We look for well-recognized, well-respected companies that have been around for a long time and are substantial in size. We do look for balance, in terms of sectors, but we have so many names we can choose from that we don’t rule anything out.”
The last time the Dow changed one of its components was in March 2015, when Apple replaced AT&T Inc. /zigman2/quotes/203165245/composite T +2.22% , which had been a component for nearly 100 years.
Blitzer compared the construction of the Dow with the S&P Total Market Index /zigman2/quotes/212181037/delayed XX:SPTMI -0.53% , which includes every U.S. stock with a market cap above $10 million.
“That rule is simple and doesn’t give us discretion,” he said, referring to the committee. “The Dow’s rules give us a good deal of wiggle room, which makes it far more active.”