Indexing: Phantom Promotions, Defiant Demotions

Doug Clark, Managing Director
Ivan Cajic, VP, Index & ETF Research

As passive investing continues to grow, so too has the impact of index changes. For the largest US companies, passive managers may hold more than 20% of a company’s public float. Changes to the underlying composition of these indices leads to significant liquidity events and, often, significant price impact.

These index events attract participants from all facets of the market, from index funds rebalancing their portfolios to active managers seeking liquidity to hedge funds seeking short-term alpha through advance prepositioning. Because of these competing forces, performance of index changes is widely uncertain and is accompanied by heightened volatility.

However, over the past year, we began to observe some consistent patterns. With the goal of quantifying these trends, we decided to investigate S&P 1500 (i.e., S&P 400, 500, 600) changes over the past year. In an effort to isolate indexrelated impact from other factors, namely corporate actions, our analysis considers only discretionary additions and deletions. We also excluded index changes where a company experienced significant price movement due to earnings, either in the days before or after an index announcement.

The results are counterintuitive, but are in line with our recent observations. What is truly surprising, are the driving factors behind this trend.

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