U.S. markets open in 8 hours 29 minutes
  • S&P Futures

    3,652.75
    +29.50 (+0.81%)
     
  • Dow Futures

    29,857.00
    +228.00 (+0.77%)
     
  • Nasdaq Futures

    12,375.75
    +98.75 (+0.80%)
     
  • Russell 2000 Futures

    1,840.90
    +20.80 (+1.14%)
     
  • Crude Oil

    45.11
    -0.23 (-0.51%)
     
  • Gold

    1,788.10
    +7.20 (+0.40%)
     
  • Silver

    22.93
    +0.34 (+1.51%)
     
  • EUR/USD

    1.1960
    +0.0026 (+0.22%)
     
  • 10-Yr Bond

    0.8440
    0.0000 (0.00%)
     
  • Vix

    20.57
    -0.27 (-1.30%)
     
  • GBP/USD

    1.3367
    +0.0035 (+0.27%)
     
  • USD/JPY

    104.3700
    +0.0460 (+0.04%)
     
  • BTC-USD

    19,471.42
    -93.12 (-0.48%)
     
  • CMC Crypto 200

    382.63
    +18.04 (+4.95%)
     
  • FTSE 100

    6,266.19
    -101.39 (-1.59%)
     
  • Nikkei 225

    26,788.63
    +355.01 (+1.34%)
     

What Dow Changes Mean For ETF Investors

·4 min read
What Dow Changes Mean For ETF Investors
What Dow Changes Mean For ETF Investors

Sometimes passive investing can feel very active, even if you’re tracking some of the oldest, most well-established indexes.

Consider the latest rejiggering of the Dow Jones Industrial Average—an example of active decision making in an index.

Without much notice, S&P Dow Jones announced that, effective Aug. 31, the DJIA would be ditching Exxon, Pfizer and Raytheon Technologies from the mix, adding Salesforce, Amgen and Honeywell as their respective replacements.

Why? To account for Apple’s recent 4-1 share split, which in a price-weighted index such as the DJIA meant Apple’s weighting in the overall index dropped fourfold. The much smaller allocation to Apple also brought down the index’s overall allocation to the technology sector.

“The announced changes help offset that reduction,” S&P Dow said in a release. “They also help diversify the index by removing overlap between companies of similar scope and adding new types of businesses that better reflect the American economy.”

Aspects To Think About

If you are a passive investor holding a fund that tracks the DJIA, such as the SPDR Dow Jones Industrial Average ETF Trust (DIA), there are a few things to consider.

First, the changes in portfolio holdings should not—immediately—change the index’s current level. The divisor S&P Dow uses to calculate the industrial average is being adjusted accordingly to protect the current value of the index, the firm said.

Remember that when the Dow was first put together, the math was simple: Add the price of all the 12 (the number was increased to 30 over the years) large industrial stocks in the portfolio, and divide by 12 (the divisor). That divisor, over the years, has changed to take into account events such as a stock split, and today is only a fraction of that original number.

Secondly, it’s an interesting—subjective, perhaps—twist that the DJIA is seeking to “better reflect the American economy” by adding companies such as Salesforce—a cloud computing firm; biotech Amgen; and prior component Honeywell, an industrial tech company tapping into everything from industrial automation to chemicals to PPE production now. While the DJIA is closely watched on a daily basis by traders and investors around the world, the index isn’t really seen as a true proxy for the U.S. market these days—it’s a basket of just 30 names weighted by price.

Of course, there’s no question that technology plays a much bigger role as a stand-alone sector as well as cross-sectors in the U.S. economy today. Not that long ago, energy was the biggest segment of the market, but things change, economies change, leadership certainly changes and the industrial average changes too.

DIA, tracking the DJIA, holds tech at about 27% of its price-weighted mix—a level this latest index rejiggering is looking to preserve after the Apple stock-split.

But finally, and most importantly, changes to the underlying holdings in the index will inevitably lead to changes in returns. At the end of the day, sector allocation matters, representation of the economy and diversification matters, but it’s the performance of the underlying securities in a portfolio that drive overall returns.

Performance Of Holdings

Since the March 23 market low, for example, Pfizer (PFE), Exxon (XOM) and Raytheon (RTX) have rallied between 26% and 34%, as the chart below shows:

 


 

In that same period, Salesforce (CRM), Amgen (AMGN) and Honeywell (HON) have delivered between 38% and 93% in gains:

 


Charts courtesy of StockCharts.com

 

Single-stock performance makes a big difference in the overall trajectory of an index—and on the returns of an ETF tracking that index.

To put that visually, Bloomberg Intelligence’s Athanasios Psarofagis shared the chart below plotting the performance difference of the newly rejiggered DJIA versus the ETF tracking it currently, DIA, if index changes had been effective this week:  

 


Source: Bloomberg via Twitter

 

Closing Thoughts

It’s not too often we see a change-up as significant as this latest one on the Dow, but they do happen. A few years ago, we saw the index kick out General Electric for the first time after a 100-year-plus tenure in the benchmark. Honeywell itself was part of the Dow until the mid-2000s before it was booted.

It is important to know what securities comprise the benchmark your ETF tracks—passive investing by no means mean being asleep at the wheel. And if you loved having access to Pfizer, Exxon and Raytheon in DIA, remember that you can still own these stocks via other ETFs. (Our ETF Stock Finder Tool can help you with that.)

Contact Cinthia Murphy at cmurphy@etf.com

Recommended Stories


Permalink | © Copyright 2020 ETF.com. All rights reserved