Index Constituent Return Bump Declining

The Standard & Poor’s research found that excess returns for stocks associated with index addition announcements have diminished sharply over time.   According to the Standard & Poor’s study, the median excess returns between announcement date and effective date of addition for those stocks added to the S&P 500 are 8.9% between mid-1998 and mid-2000, 4.5% between mid-2000 and mid-2002, and 3.6% between mid-2002 and mid-2004. A similar trend can be found for the S&P MidCap 400 and S&P SmallCap 600.

Because of several structural issues behind the decline of the index effect, the trend isn’t likely to change anytime soon, S&P said. For example:

• the growing popularity of the index effect has resulted in a surge of proprietary trading activity that seeks to exploit this arbitrage opportunity. As the competition among arbitrageurs has increased, the profit opportunity has diminished, S&P said.
• Many index funds have increasingly begun to trade around the effective date to minimize the cost of index changes.
• An increase in indexed assets for the mid- and small-cap indices provide better offset for additions caused by moves from one index to another, thus reducing net demand

“The index effect has begun to diminish thanks to changes in the trading environment and the way index funds handle these events,” said Srikant Dash, Index Strategist at Standard & Poor’s, in a news release. “We find that the decline has occurred despite a persistence of excess trading in added stocks, and robust demand of shares from index funds.”

The study is at  www.standardandpoors.com/indices .