So-called “passive” index funds, which track a pre-specified underlying index, manage over $12 trillion in assets. It is widely assumed that the managers of these funds cannot select portfolios that deviate from the index’s holdings. In Discretionary Investing by ‘Passive’ S&P 500 Funds, we show this assumption is false as a matter of both law and empirical fact. We analyze funds that track the S&P 500 – the most widely used index – and find their holdings regularly diverge from the index’s, by between 1.7% and 7.5% in the fourth quarter of 2022 alone. These deviations amount to over $60 billion in discretionary investment decisions, roughly equivalent to Target Corporation’s entire market capitalization. Our findings complicate the standard narrative around index funds and weaken many of the criticisms traditionally levied against these funds.

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