Money Left on the Table I – Passive Investing and the Effects of Reconstitution
Investors today compete relentlessly to be at the forefront, digging out every chance of profit-making ahead of their peers. With passively managed funds taking up half of the market, the reconstitution of the underlying indices leading to massive turnover in the capital market is gaining more attention from market participants. By anticipating the upcoming changes in the underlying indices, market participants buy (sell) expected additions (deletions) much before the announcement from the index providers.
In this paper, we attempted to study the impact of reconstitution across different months of a year and in various size segments. We defined the impact of reconstitution as the excess return that a hypothetical portfolio will generate if it reconstitutes in advance of the actual underlying index reconstitution. We observed the impact of reconstitution became significant in the majority of months for all the size segments when the hypothetical portfolios reconstituted four weeks before the actual reconstitution of the underlying indices. Therefore, market participants, who acted early, created a considerable impact on the reconstitutions.
- The impact of reconstitution became statistically significant in the majority of months for all the size segments when the hypothetical portfolios reconstituted four weeks before the actual reconstitution of the underlying indices
- Although the stock additions/deletions impacted the reconstitutions of the underlying indices substantially over a longer advance reconstitution period, pure weight changes of the other components also created material impact
To find out more about impact incurred by index trackers at the time of reconstitution, please click here or on the graphic below to download our white paper.
Download the second and third Paper of our Money Left on the Table Series here: Money Left on the Table II – Why You Should Think About the Timing of the Reconstitution & Money Left on the Table III – A Deeper Look into the Effects of Liquidity and Reconstitution