Index Rebalancing and Long-Term Portfolio Performance
27 Pages Posted: 20 Mar 2007
Date Written: March 2007
We examine how index additions and deletions affect long-term benchmark performance. Studying changes to the small-cap Russell 2000 index from 1979-2004, we find that a buy-and-hold portfolio significantly outperforms the annually rebalanced index by an average of 2.22% over one year and by 17.29% over five years. These excess returns result from strong positive momentum of index deletions and poor long-run returns of new issue additions. We also document the influence of index changes on small-cap equity fund returns. Index deletions enhance the benchmark-adjusted returns of the strongest performing funds by an average of 1.45% per year. Among weaker performing funds, the benefits from holding index deletions are offset by the poor returns of new issues added to the index, which the stronger performing funds generally avoid.
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