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As I understand it, inclusion of a company in the S&P500 means all ETFs that track the S&P, and some of their derivatives, must buy stock in that company. I would expect this to be a noticeable boost to the share price in the short term - the funds must buy at any price, after all.

Last week, 3 companies were added to the S&P 500. Of these, 2 experienced a brief jump on Monday, then went on to noticeable losses. It might be because both are gambling companies, but it still seems strange to see them fall so much right before inclusion in an index fund.

Is it because ETFs only start buying on the official date (next Monday?). Are the tracking funds allowed to buy in advance, spreading out the price variations?

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You are assuming that a stock will jump after the inclusion into an index is announced. However there is some issues with your assumption:

  • Inclusion is not immediate. For many indexes there is a time between the announcment of the inclusion and the actual inclusion
  • People might expect inclusion of certain stocks and buy them to bet on an index inclusion effect. This will inflate the price already long before the inclusion is announced. These people will also sell off their shares after the inclusion
  • The S&P500 is a market cap weighted index. This means that a newly included stock will typically have a low weight in the index.
  • Therefore the tracking error of not including the stock immediately is often small
  • Funds do not always rebalance their portfolio immediately. Many will have monthly or quartely rebalancing of the portfolio to reflect inclusions
  • Index funds are not the only players and index inclusion is not the only thing happening these days. Everyday's volatility might just cover the index inclusion effect
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  • For many indexes there is a time between the announcment of the inclusion and the actual inclusion Does the prospectus not state how often the ETF is brought in line with the index? – Bernhard Döbler Mar 21 at 1:17
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    This would be the rebalancing interval in the fifth bullet point. The first bullet point means that for many indexes new inclusions will be announced some weeks before they are actually included in the index. The problem here is: if we assume there is an inclusion bonus and it is sufficiently reliable, people will exploit this inclusion bonus and the stock price will already rise beforehand. Therefore at the actual inclusion date and shortly thereafter, the inclusion bonus will be small, if observable at all. – Manziel Mar 21 at 11:44

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