18 – M4 L1B 19 Index Changes V1

Index adds can drive buying of the stock that was added to a major index, while index deletions can drive selling of that stock. So, why is that? You’ll recall, that an index is not a fund. So, what causes this buying and selling when an index changes? Recall that funds and ETFs, particularly passive funds that track a major index, want to create portfolios that match that index. So any changes in the index requires a change in the funds portfolio. Even Spark Beta or actively managed funds may consider adjusting their portfolios after an index add or deletion is announced since they may use that particular index as their benchmark, and the stock universe for the portfolio may depend upon what’s in the benchmark. For example, when Monsanto was acquired in June of 2018, the S&P 500 removed Monsanto and added Twitter. Twitter’s stock increased by about five percent after the announcement as funds and ETFs that track the S&P 500 bought Twitter’s stock in order to match the index. We could follow the news for index adds and buy the stock anticipating that other funds who need to buy that stock will add momentum to the price increase in the short term. Similarly, index deletions could be a signal to sell or share the stock since funds will also sell their holdings to match the index that they’re tracking. As always, you need to use care and judgment here as it is likely that this information is very well known and therefore might not be a strong Alpha factor.