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Primary Article

The Hidden Costs of Index Rebalancing

Ananth N Madhavan and Kewei Ming
The Journal of Investing Fall 2003, 12 (3) 29-35; DOI: https://doi.org/10.3905/joi.2003.319551
Ananth N Madhavan
A managing director at ITG in New York City.
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  • For correspondence: amadhava@itginc.com
Kewei Ming
A vice president at ITG.
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  • For correspondence: kming@itginc.com
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Abstract

Periodic index rebalancing is associated with substantial price movements for the stocks added to and deleted from the index. These price changes represent significant hidden costs to portfolio managers who track the index. This article examines this issue, focusing on the dramatic return movements associated with the change of the S&P 500 index com-position on July 19, 2002, when seven non-U.S.companies were replaced by seven U.S. companies. We examine the liquidity and return patterns in these 14 stocks following the announcement date on July 9, 2002. We show that by adopting a trading strategy that spreads out trades in the period before the reconstitution date, trading costs can be dra-matically reduced without bearing significant tracking error risk. These differences can significantly improve the net performance of investment funds. More generally, these results indicate that trading strategies that provide guaranteed market-on-close prices have hidden costs to investment-managers.

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The Hidden Costs of Index Rebalancing
Ananth N Madhavan, Kewei Ming
The Journal of Investing Aug 2003, 12 (3) 29-35; DOI: 10.3905/joi.2003.319551

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The Hidden Costs of Index Rebalancing
Ananth N Madhavan, Kewei Ming
The Journal of Investing Aug 2003, 12 (3) 29-35; DOI: 10.3905/joi.2003.319551
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