If I told you that someone who invests in an index fund that tracks the S&P/TSX composite index, with the intention of buying and holding, was taking an active bet against the Canadian stock market, you’d think I was nuts. But consider this: the S&P/TSX composite index was comprised of 211 names as of December 31, 2009, but there were 3,640 listed issuers on the TSX and TSX Venture exchanges collectively.
According to Standard & Poor’s the S&P/TSX Composite Index gives you 95% coverage of the float-adjusted Canadian equity market. This is due to market-capitalization weighting where the bigger a company is, the bigger it’s weight in an index. The top name in the index (again, at December 31st, 2009) was Royal Bank. This one issue was worth about $80 billion. It’s weight in the composite index was 6.18%. But the total market cap of Canadian equities according to The TMX Group was $1.8 trillion (I’m guessing that this is non-float adjusted). That means Royal Bank’s cap-weighted weight was 4.44% if your market was every Canadian issue.
4.44% is substantially different from 6.18%. In the S&P/TSX Composite Index you would be roughly 39% overweight the true market weight of Royal Bank at this point in time.
However, from a practical point of view we would run into problems if everyone indexed a market by owning every single stock as market capacity and impact would become a limiting factor. So, for all intents and purposes tracking the headline index would be close enough that you could call it passive management. But in reality, it isn’t. One way around this is to avoid saying that your benchmark is the Canadian stock market, but rather the S&P/TSX Composite Index.
So really my point is that the Canadian Stock Market and the S&P/TSX Composite Index are not exactly the same things.