Do Index Fund Managers Trade Opportunistically around Index Changes? An Empirical Examination of S&P 500 Index Funds

Abstract

Numerous studies have documented abnormal returns available to investors around index changes. S&P 500 index fund managers face competitive pressures to replicate the index as close as possible or risk the loss of investors to competing funds. As a result, these fund managers have incentive to take actions to reduce any underperformance. The authors examine whether S&P 500 index funds are able to opportunistically trade around index changes between the announcement date and the effective date in an effort to reduce tracking error. They do find evidence of these funds using changes to the S&P 500 as a source of opportunity to capture performance and reduce tracking error. This evidence suggests that the wealth transfer from index fund investors to arbitrageurs around S&P 500 index changes documented in the literature may be far less pronounced than originally thought.

TOPICS: Mutual fund performance, manager selection, portfolio construction