The Standard & Poor's 500 Index has come a long way since 1957, the year it was introduced. An index fund wasn't even a twinkle in Jack Bogle's eye back then, and corporate America looked a whole lot different. For one thing, 400 of the companies in the S&P 500 were industrial companies.
"If we start with long sweeps of time, the index was clearly conceived as being industrial companies," said David Blitzer, who has headed the investment committee that determines the makeup of the index for more than two decades. "It was inspired by the Dow Jones Industrial Average and didn't have much in the way of banks and financials."
But the rule of industrial stocks was short-lived. Thanks to the 1973 Arab oil embargo, energy stocks became the dominant industry in the S&P 500. "For the first time, 'industrial' was not a good description of the nonfinancial part of the economy," Mr. Blitzer said.
As of 2016, the latest data available, about $2.9 trillion is directly indexed to the S&P 500. Two funds — the Vanguard Index 500 Fund (VFINX) and the SPDR 500 ETF (SPY) — account for nearly a quarter of the money directly tied to the index. Another $5.7 trillion is benchmarked to the S&P 500.
The rule requiring 400 industrial companies went by the boards in 1988. "We were having trouble finding 400 industrial companies to put in the index," Mr. Blitzer said. "We dropped the rigid numbers and went down to about 385 industrials in a couple of months."
By the 1990s, the dominant industry was technology, accounting for about a third of the index. It did not end well. The weighting would have been higher if S&P didn't have a rule saying that members had to be financially viable, Mr. Blitzer said.
"When tech was 33% of the index, we were actually underweighted in tech because most of the flaky companies weren't making money. If it weren't for that rule, it would have been 35%, 37%."
After the tech wreck of 2000-2000, it was the financials' turn to dominate the index. That didn't end well, either. "They went south in a big way," Mr. Blitzer said. Now, tech is back — about 22% of the index — and health care is on the rally.
"It's an increasing chunk of the index and an important part of the economy and stock market return," he said. "What we now call industrials is a narrow thing and includes some transport. It's a stable but declining part of the economy. If we were to look at employment in industry, it's a tiny portion of the economy."
It's a trend that Mr. Blitzer thinks will continue. "Health care, finance, entertainment and communications are going to be growing sectors. One factor that could change: We're seeing a backlash against globalization: One reason U.S. manufacturing has declined is that it has been replaced in different places."
And industries meld into one another now. For example, the biggest area of the S&P 500 now isn't technology, strictly speaking. "A lot of it is media and entertainment," Mr. Blitzer said. "There as substantial numbers of people who use Facebook rather than any telecommunications equipment." And Amazon is considered a retailer and therefore part of the consumer discretionary industry, even though it also has an enormous web-hosting business.
"In some ways, innovation gets absorbed more quickly and penetration is faster than it used to be," Mr. Blitzer said. Electricity started in the 1880s with Thomas Edison, for example, but it wasn't until the buildup to World War II that all factories were fully electrified. Similarly, telephones were also invented in the 1880s, but they didn't break 80% household penetration until after the World War II. "But cell phones haven't been around 40 years, and they certainly have more than 80% penetration," Mr. Blitzer said.
One other big change for the S&P 500: More than half its earnings come from overseas. "It's a peculiar thing: If you want a diverse portfolio, you can have a pretty good global portfolio with the S&P 500," Mr. Blitzer said.
The current fluidity of the S&P 500 has made some question whether the index is really an index or an actively managed entity — something that rankles Mr. Blitzer. "There's a pretty robust document outlining the methodology, and it is followed. But more than that, every index has something behind it, whether it's an individual or committee who wrote the rules, and they have to be reviewing those rules at least once a year. What we bring is an advantage in that we have a committee that meets once a month so that if issues come up, we can deal with them quickly."
One example: The collapse of American International Group Inc. during the financial crisis. "It was two or three weeks after the government took control of Freddie Mac and Fannie Mae, and one morning, three or four days after Lehman Brothers collapsed, everyone discovered that AIG had credit default swaps they couldn't pay off. Uncle Sam poured money in and took a big position in the stock. "We didn't have a paragraph in the S&P 500 document that said what to do when the government takes over one of the biggest companies in the world." AIG was replaced, although it was put back into the index five years later after recovering.
Mr. Blitzer currently oversees the eight-person committee, although there's not set number of people for it. And membership comes with restrictions: Members can't trade stocks or negotiate contracts for use of the index. "If a company makes threats because we don't put them in the index, that's their problem, not mine," Mr. Blitzer said.
Mr. Blitzer seems content with the way the S&P 500 works. "At the end of the day, we're not throwing darts," he said. "We do pay attention to the markets in part because in extreme cases, we have some discretion. We have a rule book, but it's not big enough to hide behind."