Indexing Bias

By Derek Benedet, CMT & Craig Basinger, CFA

You won’t find this bias in any of the research or books on behavioral finance; we are inventing a new one. Indexing Bias is how investors view a company once it has been added or deleted from an index. One would think that a company added to the S&P 500 or TSX Composite is good news and the near-term prospects for a rising share price would be high. Conversely, being removed from an index does sound negative, almost like punishment. However, we have found a reversion which sees those added to the index underperforming those removed. The charts to the right measure average performance relative to the market following inclusion or deletion from the index. There is a substantial difference, with those dropped doing much better than those added.

The Analysis

Obtaining the historical information of constituency data was not as easy as expected. Indices do have greater turnover than many might expect; including acquisitions, the number of companies being added and deleted from the index averaged almost 100 per year across both the TSX and S&P 500. Tracking down the historical component and the future returns took a lot of detective work. Going line by line for 15 years of market data retells a lot of memorable stock stories. Spectacular failures like Enron, WorldCom, Nortel, and Sino-Forest stand out like sore thumb. But there were also plenty of ‘what if’ opportunities for companies with bright futures ahead of them. Index add dates for Google (2006) and Amazon (2005) are but just two.

The period of analysis was from 2001 for the S&P 500 and 2003 for the TSX Composite. During these periods there were 774 changes to the S&P 500 and 507 changes to the TSX. For the analysis, we looked at the names that were added and dropped from the index and the subsequent 1, 3, 6 and 12 month relative performance to the index. The timing was from the day the stock was actually added or removed. A significant amount of the names removed from the index were due to being acquired, these were excluded from our analysis as those companies simply ceased to exist. As a result this analysis covers just companies added and those removed that were not subject to an acquisition.


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Charts are sourced to Bloomberg unless otherwise noted.

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Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend on or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” intend,” “plan,” “believe,” “estimate” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained in this document are based upon what Purpose Investments [and the portfolio manager] believe to be reasonable assumptions, Purpose Investments [and the portfolio manager] cannot assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on the FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.


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