The Avoidable Costs of Index Rebalancing

43 Pages Posted: 6 May 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. For the S&P 500 Index, in the year after a change in the index, additions lose relative to discretionary deletions by about 22%. 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 (bps). This benefit doubles when we cap-weight a portfolio not selected on market value, but based on the fundamental size of a business or 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)

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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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