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Suppose an index is changed in so far as Company A is removed and Company B is added.

  • Are these changes reflected immediately in an ETF reflecting said index?

I suppose that when an AP creates ETF "shares" by adding a basket of securities, this happens with the new constellation, i. e. with B and without A.

  • However, when an AP "destroys" (redeems?) ETF "shares", does this happen in the old constellation? That would make sense because it would help the transition from the old to the new constellation.

Apart from the APs adding or removing baskets of constituent shares,

  • can and will the ETF manager (or the AP?) buy and sell shares in order to get close to the new index constellation?

In this case, I suppose large amounts of A will be sold and large amounts of B will be bought. This will surely affect the price of these stocks.

  • Is it possible to say how much the impact will be on each side?
  • Or will the exchange be slowly over several days and the impact will be low?
  • Will, in this case, the ETF (or the AP) act as a kind of "market maker" for these stocks?

EDIT: While further thinking about this, I think that remaining stocks of A as well as "missing" stocks of B might as well contribute to the tracking error. But I think in the long run, these mismatches are probably eliminated in a slow, careful way.

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There are a lot of questions here.

In short, when a company is added or removed from the index the ETF tracks, the ETF will drop or add shares of those companies to match the index again.

Different ETFs will handle it in different ways depending on the rules of the exchange and their own guidelines. Some will buy over a few weeks and migrate slowly to the new index, others buy in advance of the index change and some purely mechanical ones will just update when the algorithm says to. I suspect they would actively avoid becoming 'market makers' of any sort.

In practice, the companies added and removed from indexes are not secret and the rules of the index mean that it should be fairly straightforward even for retail investors to 'get ahead' of the index fund and work out which companies will be dropped and which will be added the next time the index is recomputed. However, I would expect other investors have noticed that effect too...

It's difficult to say how much the impact would be. I would expect different sizes of index to have different impacts. For example, in the S&P 500 1 share makes up about 0.2% of the portfolio, in the FTSE 100 it makes up 1% of the portfolio (weighted indexes won't be that simple, but the basic idea is the same). The size of the company, the size of the index funds and the number of companies in the index will all have a bearing.

There is a Bloomberg opinion article that I referenced at https://www.bloomberg.com/opinion/articles/2015-07-07/can-you-really-game-index-funds-

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  • A company leaving the index won’t generally make up (for example) 1% of the FTSE-100, because in general it’s the smallest ones that drop out. The smallest company has a market cap of about £2 billion and the total market cap is about £2 trillion, so if the smallest company drops out that’s a 0.1% change, not a 1% change.
    – Mike Scott
    Feb 29, 2020 at 21:34
  • Thank you for your answer, which essentially is "it depends" and that there are no general guidelines. And thanks for the article.
    – glglgl
    Mar 2, 2020 at 14:53

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