The Avoidable Costs of Index Rebalancing

48 Pages Posted: 6 May 2022 Last revised: 7 Dec 2022

See all articles by Robert D. Arnott

Robert D. Arnott

Research Affiliates, LLC

Chris Brightman

Research Affiliates, LLC

Vitali Kalesnik

Research Affiliates Global Advisors

Lillian J. Wu

Research Affiliates, LLC

Date Written: May 3, 2022

Abstract

Traditional capitalization-weighted indices generally add stocks with high valuation
multiples after persistent outperformance and sell stocks at low valuation multiples after persistent
underperformance. It’s well-known that the price impact of these changes can be large once a
change is announced. The subsequent reversal is less well known. For example, in the year after a
change in the S&P 500 Index, discretionary deletions beat additions by 22%, on average. Simple
rules, such as trading ahead of index funds or delaying reconstitution trades by 3 to 12 months,
can add up to 23 basis points a year. This benefit roughly doubles when we cap-weight a portfolio
selected based on the fundamental size of a company’s business or on its multi-year average
market-cap.

Keywords: Indexation, Portfolio Construction, Passive Investing, Transaction Costs, Optimal Trading.

JEL Classification: G11, G12, G14, G23

Suggested Citation

Arnott, Robert D. and Brightman, Chris and Kalesnik, Vitali and Wu, Lillian J., The Avoidable Costs of Index Rebalancing (May 3, 2022). Available at SSRN: https://ssrn.com/abstract=4099610 or http://dx.doi.org/10.2139/ssrn.4099610

Robert D. Arnott (Contact Author)

Research Affiliates, LLC ( email )

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Chris Brightman

Research Affiliates, LLC ( email )

620 Newport Center Dr
Suite 900
Newport Beach, CA 92660
United States

HOME PAGE: http://www.researchaffiliates.com

Vitali Kalesnik

Research Affiliates Global Advisors ( email )

16 Berkeley Street
London, W1J 8DZ
United Kingdom
+44 2039299880 (Phone)

HOME PAGE: http://https://www.researchaffiliates.com/en_us/home.html

Lillian J. Wu

Research Affiliates, LLC ( email )

620 Newport Center Dr
Suite 900
Newport Beach, CA 92660
United States

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