5 ms·

Yes sometimes companies are delisted from the S&P500, but if you invest in an S&P500 index fund, then your investment is also automatically adjusted to remove t

by mrb 10y ago

Yes sometimes companies are delisted from the S&P500, but if you invest in an S&P500 index fund, then your investment is also automatically adjusted to remove that company. Which makes me think: with index funds becoming more and more popular, should we see bigger and bigger crashes of stocks when they are removed from an index?

dforrestwilson 10y ago
Potentially yes, but some hedge funds play the index dynamic by trading into or out of stocks before/after they are added.
SilasX 10y ago
And then that index fund has to take the loss that comes with having bought a stock that failed and sell at a loss, while not capturing the gains of stocks that got big enough to make it on the index. Shouldn't the index "return" thus diverge from the return of an actual index fund in practice given enough years?
- jonknee 10y ago
  That's not how it works, the return of the index is the actual return of the included stocks while they are in the index. There will be winners and losers, but the return is actually what you get.
  - ced 10y ago
    I'd appreciate if you could expand on that, because I share the same concern as GP. It seems to me that the index fund has to sell a lousy company at a low price (since it's being delisted) and buy a strong one that's being included in the index. Whereas the index, being just a number, can magically perform the swap without taking a hit.
    - jonknee 10y ago
      Sometimes it's OK to sell a lousy company at a low price--it's a lousy company! The beauty of a wide index fund like the S&P is that any one company diving won't hurt you. Companies typically last in the S&P for a long time, so the potential gains of adding companies earlier or selling them at a different time average out. Even Facebook has more than doubled since being added to the S&P and that's the definition of a strong growing company. If you really like a company that is being booted from the S&P you can just go buy it directly after the announcement and you'll most likely be able to pick it up on quite a discount. You can use different indexes if you want to have smaller companies (the Russell 2000 is a good choice), but the whole point of the S&P is that it is made up of established firms. Perhaps lower reward, but also lower risk.
      - deleted 10y ago
        [deleted]
      - robryan 10y ago
        Is there any data out there on variations? It would be interesting to see how other strategies compare such as buying the next 100 largest market caps outside the S&P 500, also not selling stocks that are removed.
    - kgwgk 10y ago
      The index "magically performs the swap" doing a calculation equivalent to selling at the rebalancing date the stocks that get out of the index (and buying those that replace them) at their price that day.
      - ced 10y ago
        Oh, that makes sense. Do you have any reference for it? I found this explanation http://www.investopedia.com/ask/answers/040215/what-does-sp-500-index-measure-and-how-it-calculated.asp http://www.investopedia.com/ask/answers/040215/what-does-sp-..., but it doesn't seem all that trustworthy, and it seems to suggest that S&P doesn't account for survivor bias.
  - SilasX 10y ago
    I don't see how that addresses the dynamic I described, beyond re-asserting the conclusion I was questioning.
    - jonknee 10y ago
      > Shouldn't the index "return" thus diverge from the return of an actual index fund in practice given enough years? That's what I am taking issue with.
      - SilasX 10y ago
        That much I get. I was asking for your basis for disputing the logic; all I see so far is a reassertion of the original conclusion. If you don't understand what dynamic I was describing, please say so. As it stands, I don't see what the reason is that you're trying to give for why it is wrong.
  - kevinpet 10y ago
    The return of the ETF is only as good as what the portfolio managers can accomplish in reality. They are very good at this, but the cost is there. It's referred to as tracking error.
    - kgwgk 10y ago
      The tracking error is not really "a cost", it's about variability. An ETF can have low tracking error but high cost if the returns are highly correlated with the index but systematically lower. http://www.etf.com/etf-education-center/21030-understanding-tracking-difference-and-tracking-error.html http://www.etf.com/etf-education-center/21030-understanding-...
shostack 10y ago
Likewise, are there bigger potential crashes for Mainstreet Investors in store as more and more of the populace shift to index funds? If there's a critical mass of people on index funds, what sorts of changes are there to overall risk and liquidity in the market?

by mrb 10y ago

dforrestwilson 10y ago

Potentially yes, but some hedge funds play the index dynamic by trading into or out of stocks before/after they are added.

SilasX 10y ago

And then that index fund has to take the loss that comes with having bought a stock that failed and sell at a loss, while not capturing the gains of stocks that got big enough to make it on the index. Shouldn't the index "return" thus diverge from the return of an actual index fund in practice given enough years?

jonknee 10y ago
That's not how it works, the return of the index is the actual return of the included stocks while they are in the index. There will be winners and losers, but the return is actually what you get.
- ced 10y ago
  I'd appreciate if you could expand on that, because I share the same concern as GP. It seems to me that the index fund has to sell a lousy company at a low price (since it's being delisted) and buy a strong one that's being included in the index. Whereas the index, being just a number, can magically perform the swap without taking a hit.
  - jonknee 10y ago
    Sometimes it's OK to sell a lousy company at a low price--it's a lousy company! The beauty of a wide index fund like the S&P is that any one company diving won't hurt you. Companies typically last in the S&P for a long time, so the potential gains of adding companies earlier or selling them at a different time average out. Even Facebook has more than doubled since being added to the S&P and that's the definition of a strong growing company. If you really like a company that is being booted from the S&P you can just go buy it directly after the announcement and you'll most likely be able to pick it up on quite a discount. You can use different indexes if you want to have smaller companies (the Russell 2000 is a good choice), but the whole point of the S&P is that it is made up of established firms. Perhaps lower reward, but also lower risk.
    - deleted 10y ago
      [deleted]
    - robryan 10y ago
      Is there any data out there on variations? It would be interesting to see how other strategies compare such as buying the next 100 largest market caps outside the S&P 500, also not selling stocks that are removed.
  - kgwgk 10y ago
    The index "magically performs the swap" doing a calculation equivalent to selling at the rebalancing date the stocks that get out of the index (and buying those that replace them) at their price that day.
    - ced 10y ago
      Oh, that makes sense. Do you have any reference for it? I found this explanation http://www.investopedia.com/ask/answers/040215/what-does-sp-500-index-measure-and-how-it-calculated.asp http://www.investopedia.com/ask/answers/040215/what-does-sp-..., but it doesn't seem all that trustworthy, and it seems to suggest that S&P doesn't account for survivor bias.
- SilasX 10y ago
  I don't see how that addresses the dynamic I described, beyond re-asserting the conclusion I was questioning.
  - jonknee 10y ago
    > Shouldn't the index "return" thus diverge from the return of an actual index fund in practice given enough years? That's what I am taking issue with.
    - SilasX 10y ago
      That much I get. I was asking for your basis for disputing the logic; all I see so far is a reassertion of the original conclusion. If you don't understand what dynamic I was describing, please say so. As it stands, I don't see what the reason is that you're trying to give for why it is wrong.
- kevinpet 10y ago
  The return of the ETF is only as good as what the portfolio managers can accomplish in reality. They are very good at this, but the cost is there. It's referred to as tracking error.
  - kgwgk 10y ago
    The tracking error is not really "a cost", it's about variability. An ETF can have low tracking error but high cost if the returns are highly correlated with the index but systematically lower. http://www.etf.com/etf-education-center/21030-understanding-tracking-difference-and-tracking-error.html http://www.etf.com/etf-education-center/21030-understanding-...

shostack 10y ago

Likewise, are there bigger potential crashes for Mainstreet Investors in store as more and more of the populace shift to index funds? If there's a critical mass of people on index funds, what sorts of changes are there to overall risk and liquidity in the market?