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Index Changes and Losses to Index Fund Investors

Honghui Chen, Gregory Noronha and Vijay Singal
Financial Analysts Journal
Vol. 62, No. 4 (Jul. - Aug., 2006), pp. 31-47
Published by: CFA Institute
Stable URL: http://www.jstor.org/stable/4480758
Page Count: 17
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Since scans are not currently available to screen readers, please contact JSTOR User Support for access. We'll provide a PDF copy for your screen reader.
Index Changes and Losses to Index Fund Investors
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Abstract

Because of arbitrage around the time of index changes, investors in funds linked to the S&P 500 Index and the Russell 2000 Index lose between $1.0 billion and $2.1 billion a year for the two indices combined. The losses can be higher if benchmarked assets are considered, the pre-reconstitution period is lengthened, or involuntary deletions are taken into account. The losses are an unexpected consequence of the evaluation of index fund managers on the basis of tracking error. Minimization of tracking error, coupled with the predictability and/or pre-announcement of index changes, creates the opportunity for a wealth transfer from index fund investors to arbitrageurs.

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