Investment officeAugust 26 2020

Chief Investment Officer Update: Rare changes to the Dow Jones

2 mins read

StJohn Gardner

Chief Investment Officer

The Dow Jones Industrial Average is the most well-known share index in the USA. The Dow Jones was developed by Charles Henry Dow and originally contained just 12 American companies when it was published for the first time in May 1896, opening at a level of 40.94 points. Today, the Dow Jones consists of the 30 most important market-leading companies on the American stock exchange with the index being calculated according to the constituents share prices.

Changes to the constituent companies of the Dow Jones are rare but at the end of August there will be a number of changes, prompted by Apple’s four-for-one stock split, a move that would otherwise dramatically reduce the weight of technology companies within the Dow Jones. The sharp rise in Apple’s stock price this year has been such that it now represents a mighty 12% of the index, making it the most influential stock in the index calculation. The stock split will bring this down to just 3%, triggering a broader re-shuffle of the remaining businesses.

Falling out of the index will be Pfizer, the biopharmaceutical company that discovers, develops and provides medicines, vaccines and consumer healthcare products; also Exxon Mobil, the oil major and Raytheon Technologies, a multinational industrial conglomerate. These latter two companies are the progeny of firms that entered the Dow Jones over 90 years ago, around the time the index was broadened from 12 to 30 names.

Replacing them will be Salesforce (a leader in customer management cloud software and computing), Amgen (a multinational pharmaceutical company) and Honeywell International (a global manufacturing company offering commercial technologies in aerospace, sensing, controllers and security). It is a homecoming for Honeywell, having been displaced from the Dow in 2008.

The result of these changes is that United Health (a healthcare product and insurance services business), Home Depot (a home improvements retailer) and Amgen will become the top three firms influencing the performance of the index.

Nevertheless, the narrow scope of the index, given it tracks just 30 firms in the US markets, means the index is rarely used outside of the United States for performance evaluation. Instead, the S&P 500 has taken over as the internationally recognised index of choice to represent the broader health of corporate USA. Covering 500 of the largest firms, and given that the value of US quoted companies represent around 60% of global company market capitalisation, the index is more akin to the indices used in other developed markets to cover the diversity of their larger firms such as the TOPIX, FTSE100 and CAC40. It is these indices that exchange traded funds (ETFs) follow and adjust to when constituents change and so the scope for hedge funds to arbitrage the price changes that typically follow, as full replication ETFs are forced to apply the component changes, seems limited.