What the S&P 500 Index Rebalance Means for Investors and Index Managers
- Stock Market
- Portfolio Construction
- Markets & Economy
The third quarter S&P 500 Index , effective at the onset of trading on Monday, September 18, was among the largest since at least 2017 based on total estimated value of related trading. The rebalance added two companies (Blackstone, Airbnb) and removed two (Newell Brands, Lincoln National). It also adjusted the weightings on a number of companies, including Amazon, Tesla, Apple and Alphabet. We analyze how the rebalance affected index composition and performance of the targeted securities, and how rebalances impact investors and index portfolio managers.
Why are indexes rebalanced?
Index providers regularly rebalance their indexes to account for:
- Addition or removal of companies: A company must pass several criteria related to market cap, liquidity and earnings in order to be eligible for inclusion in the S&P 500 and may be removed for failing to meet these criteria. Because constituents are selected by a committee, meeting criteria is necessary, but not sufficient for inclusion in the S&P 500.
- Float increases or decreases: The float is the amount of total shares that are available for trading in public markets. A company’s float changes as long-term strategic shareholders change the positions they hold, affecting shares available for public trading. For example, company insiders may buy or sell shares on the open market, increasing or decreasing the float.
- Share increases or decreases: As a company issues or , the number of shares in the index changes.
Each index provider follows its own rebalancing schedule and rules. S&P-Dow Jones, which owns the S&P 500 Index, rebalances its line of market capitalization indexes quarterly on the third Friday of March, June, September and December.
In a share repurchase, a public company buys company shares previously sold to the public, potentially to increase financial metrics such as earnings per share or halt a declining stock price.
In an index rebalance, index providers regularly change the companies included and their weightings to keep their indexes relevant to investors.
Analysis of the September S&P 500 Index Rebalance
S&P-Dow Jones announced the changes to the S&P 500 on after the market closed on September 1, effective prior to the open of trading on Monday. The addition of private equity investor Blackstone and home rental company Airbnb together represent a 0.35% weight in the index. The elimination of insurance provider Lincoln National and consumer products company Newell Brands, both migrated to the small-cap S&P 600 Index, represent a combined 0.02% weight. In terms of the top changes to companies already in the index, the weightings of Amazon and Tesla rose because of increases in their float while Apple’s weighting fell because of a share decrease. More details on key weight changes are in Exhibit 1.
As an index portfolio manager, we look at increased weightings for companies as “buys” and decreased weightings as “sells” as that is how we’ll need to trade the portfolio to align with the rebalancing. The weightings of the buys and sells must be equal to maintain the index, and in this case each side of the S&P 500 rebalance represented a 0.65% weighting in the index.
This was the second largest rebalance based on the estimated value of the related trading since December 2017, according to Instinet. The buy weightings include the 0.35% for the two new companies, 0.26% due to float increases and 0.04% for share increases. The sells included the 0.02% reduction for the elimination of the two companies, 0.11% for float decreases, 0.47% for share decreases and 0.04% for funding. Funding is when index managers sell shares in the index portfolio to fund purchases of other shares in order to match the rebalance, as the weightings increases and decreases in a rebalance are almost never identical. All weights mentioned above are based on September 1 close prices.
It’s important to note that these rebalances also change the sector composition of the index, as shown in Exhibit 2. Weightings for the consumer staples and consumer discretionary sectors increased the most, while information technology and health care fell the most.
EXHIBIT 1: KEY CHANGES IN THE S&P 500 INDEX REBALANCE
The rebalance added Blackstone and Airbnb to the index, while weightings to Apple and Alphabet fell slightly on share decreases.
EXHIBIT 2: Sector Rebalance: Consumer Staples Gained While Tech Fell
As a result of changes to the composition of the index, sector weightings also changed, highlighted by gains in consumer staples and consumer discretionary along with declines in information technology and health care.
Performance: Buys Outpaced the Sells
Since S&P-Dow Jones announced the rebalance after the close of trading on September 1, the buys discussed above outperformed the sells by 6.8% through September 15 (see Exhibit 3). We attribute some of this difference to the rebalance, as index managers move money in and out of affected securities after the announcement. Among the buys, new additions Blackstone rose 8.9% and Airbnb rose 7.6%, with a good portion of the gains coming after the market closed on September 1.
EXHIBIT 3: Performance Went the 'Right Way'
Overall, this rebalance went the "right way" based on expected flows, with the buys (weight increases) outpeforming the sells (weight decreases) by 6.8%.
What the Rebalance Means to Investors and Index Managers
As you can see, indexes aren’t static, and must be adjusted periodically to maintain their relevance. We think investors should stay on top of how their , in particular changes to sector weightings and additions or deletions of individual securities. Such changes may alter the profiles of all portfolios benchmarked to indexes because they are not only used for passive vehicles but as the universe from which active portfolios select as well. Understanding this interaction is important for investors as they view their overall equity holdings.
For managers of index portfolios such as us, rebalancing periods spark lively collaboration. We must rebalance every index portfolio with the aim of achieving our primary objective: Match the risk and return characteristics of the index. There is almost no room for error, as index investors have little to no tolerance for tracking error when it comes to their index investments.
To exactly match the index returns, index portfolios need to buy and sell at the closing prices on the effective date, assuming zero transaction costs. As a matter of practice, trading the entire rebalance at once may meet the primary objective but potentially cause index investors to purchase shares at temporarily inflated prices due to the significant amount of buying pressure from the rebalance. Therefore, portfolio managers and traders must work closely together to manage the potential market impact from the abnormally high volumes being traded.
For example, rather than trading a large amount of volume in a given stock entirely at the closing auction on the effective date of the rebalance, index managers may trade some of the positions early to manage liquidity. How early requires a careful balance between impact and opportunity cost, but nonetheless early trading may help avoid wealth erosion.
Like other rebalances, this one sparked a good deal of trading. Blackstone’s daily trading volume on rebalance day was over 25 times its previous 30-day average, while daily trading for Airbnb, Newell Brands and Lincoln National reached well over 10 times their averages.
We think implementation of these changes in index portfolios requires a thoughtful approach with the aim of keeping tracking error to a minimum while ensuring that the market impact and trading costs related to the rebalancing don’t erode wealth over time.
Why Index Rebalances Matter
We think investors should stay on top of how their passive investments in indexes change over time, in particular changes to sector weightings and additions or deletions of individual securities. Such changes may alter, over time, the risk and reward profiles of passive index investments and benchmarks for active investments.
Interested in learning more about our expertise and how we can help?
For Asia-Pacific (APAC) and Europe, Middle East and Africa (EMEA) markets, this information is directed to institutional, professional and wholesale clients or investors only and should not be relied upon by retail clients or investors. The information contained herein is intended for use with current or prospective clients of Northern Trust Investments, Inc (NTI) or its affiliates. The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. NTI or its affiliates may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, its accuracy and completeness are not guaranteed, and is subject to change. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor.
This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. Indices and trademarks are the property of their respective owners. Information is subject to change based on market or other conditions.
All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, advisor risk, and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe NTI or its affiliates’ efforts to monitor and manage risk but does not imply low risk.
Past performance is not a guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by NTI or its affiliates. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and/or alternative strategies in general. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Net performance returns are reduced by investment management fees and other expenses relating to the management of the account. Gross performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. For additional information on fees, please refer to Part 2a of the Form ADV or consult an NTI representative.
Forward-looking statements and assumptions are NTI or its affiliates’ current estimates or expectations of future events or future results based upon proprietary research and should not be construed as an estimate or promise of results that a portfolio may achieve. Actual results could differ materially from the results indicated by this information.
Hypothetical portfolio information provided does not represent results of an actual investment portfolio but reflects representative historical performance of the strategies, funds or accounts listed herein, which were selected with the benefit of hindsight. Hypothetical performance results do not reflect actual trading. No representation is being made that any portfolio will achieve a performance record similar to that shown. A hypothetical investment does not necessarily take into account the fees, risks, economic or market factors/conditions an investor might experience in actual trading. Hypothetical results may have under- or over-compensation for the impact, if any, of certain market factors such as lack of liquidity, economic or market factors/conditions. The investment returns of other clients may differ materially from the portfolio portrayed. There are numerous other factors related to the markets in general or to the implementation of any specific program that cannot be fully accounted for in the preparation of hypothetical performance results. The information is confidential and may not be duplicated in any form or disseminated without the prior consent of NTI or its affiliates.
This information is intended for purposes of NTI and/or its affiliates marketing as providers of the products and services described herein and not to provide any fiduciary investment advice within the meaning of Section 3(21) of the Employee Retirement Income Security Act of 1974, as amended (ERISA). NTI and/or its affiliates are not undertaking to provide impartial investment advice or give advice in a fiduciary capacity to the recipient of these materials, which are for marketing purposes and are not intended to serve as a primary basis for investment decisions. NTI and its affiliates receive fees and other compensation in connection with the products and services described herein as well as for custody, fund administration, transfer agent, investment operations outsourcing, and other services rendered to various proprietary and third-party investment products and firms that may be the subject of or become associated with the services described herein.
Northern Trust Asset Management is composed of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K., NT Global Advisors, Inc., 50 South Capital Advisors, LLC, Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.
Not FDIC insured | May lose value | No bank guarantee