Press Releases

Solactive Investigates the Impact of Arbitrageurs on Index Trackers at the Time of Reconstitution in New White Paper Series ‘Money left on the Table’

In today’s investment world, index benchmarks are a widely utilized instruments, and major benchmarks are well-recognized by financial professionals all over the globe. Given this reputation and influence, large numbers of funds follow their allocation and constituents, which raises questions of how benchmarks are used on a large scale, what their main characteristics are, and, most notably, how will they be exploited by market participants. To study the impact that arbitrageurs have on index trackers at the time of rebalancing of the indices, Solactive conducted broad research and will publish a three-paper series over the next weeks, investigating deeply into the topic.

The first paper called ‘Passive Investing and the Effects of Reconstitution’ suggests that when measuring the impact of reconstitutions, investors and asset managers should not only look at stock additions and deletions. The paper reflects how advance reconstitution has a solid excess return across different months of a year and in various size segments. This return is attributed not only to stock additions and deletions, but also to the pure reweighting of the underlying index’ components. Therefore, highly cost-conscious index investors are invited to reckon this impact of reconstitution as it generates a noteworthy drag on performance.

The effectiveness of the timing of the reconstitution of indices is examined closely in the second white paper labeled ‘Why You Should Think About The Timing of the Reconstitution‘. The research found statistically insignificant differences in historical returns, random pattern of ranking by the impact of reconstitution, and similarity of turnover amongst indices reconstituted in different months of a year within each size segment, which implies that spreading reconstitution over several periods may be one of the ways to mitigate the effects of the unmanageable timing factor.

The last white paper, which will be released publicly in two weeks, deals with ‘A Deeper Look into the Effects of Liquidity and Reconstitution‘. There, Solactive investigated the effect of liquidity on the impact of reconstitution using a spectrum of indices moving from float market capitalization weights towards liquidity weights, finding that a decrease in the impact of reconstitution is accompanied by higher turnover. Therefore, the findings suggest that investors should weigh in the trade-off between the impact of reconstitution and costs from turnover in order to achieve breakeven in overall costs.

“With the rise of passive investment, indices are commonly used, and names of major benchmarks are known all over the globe. We are talking about large sums of money flowing in the passive industry, and with this fact in mind, it is utterly important to understand the principle behind indices’ reconstitution – of which many are not aware – and to comprehend what is actually happening in this process,” comments Timo Pfeiffer, Chief Markets Officer at Solactive. “We are very proud to contribute with our research on navigating this known issue, which is exceedingly relevant for every asset manager or service provider that tracks benchmarks in any form.”

The white papers may be obtained prior to their public release in strict adherence to an embargo by individual request via press@solactive.com

Download the white paper ‘Passive Investing and the Effects of Reconstitution’  via this link:  Money Left on the Table – Passive Investing and the Effects of Reconstitution