Benjamin Felix

They're going to change the landscape of the broader market.

Now in response, we've talked about indices.

have to rebalance to remain reflective of the broader market.

That's why they exist.

Market cap weighted indices will rebalance in response to stock market composition changes, which includes a whole bunch of things, including buybacks and seasoned equity offerings, as I mentioned earlier, but also IPOs.

In making those changes, indexes and index funds, they're implicitly engaging in a form of market timing.

That language comes from Marco Salmon's paper on this topic.

Doesn't be really bad market timing though.

And again, as we talked about earlier, the issuers, the companies that are listing on the public market, they'll generally want to issue stock when their own company's valuation is high and buy back stock when their company valuation is low.

Indexes and index funds, because their goal is to track indices that reflect the market, end up systematically buying high and selling low.

at the margins.

I want to reiterate, this isn't not a death blow for index funds.

It's just a thing.

I'll put a number to it in a second.

So in Marco Salmon's 2025 paper, which is now published in the Journal of Financial Economics, which is pretty cool.

We had him on before it was published to talk about it.

Index rebalancing and stock market composition do indexes time the market is the paper.

It estimates that that adverse selection is what he called it in an earlier draft of the paper, but that market timing ends up creating a performance drag of between 47 and 70 basis points per year relative to a delayed rebalancing approach.

It waits like 12 months, for example, to reflect changes in market composition.

So there is like a lasting negative effect on index fund returns that could be avoided if index funds delayed rebalancing, if they prioritized expected returns rather than tracking error to an index.