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Comment by faitswulff | Hacker News Reader

What happens to your money if you invest in an index fund and companies drop out of the index?

The fund rebalances regularly. Before the company is dropped out its value will have dropped, of course, causing the entire fund to drop proportionally in value.

Index funds typically rebalance quarterly, I believe. The index also rebalances, usually called reconstitution [1]; the Russell indexes rebalance yearly, for example.

Which means there can be a discrepancy between the fund and the index at any given time. This can result in arbitrage opportunities, I believe.

Interestingly, the selling and purchasing involved in adding or removing a stock from an index/fund also has an effect on the market [2].

[1] https://www.investopedia.com/terms/r/reconstitution.asp

[2] https://www.cxoadvisory.com/miscellaneous/strategies-for-exp...

The broad index funds (VTI, Russel) are indexed to market cap, so when individual stock prices change, it stays balanced or very close to it.

When a fund rebalances, it has tax consequences, so funds are incentivized not to do it.

When a company drops out of the index, the fund sells all its shares in it and buys shares of the new company that took its place.

But it should be said that the price that the fund manages to sell the shares at could be far lower than the price at the time the company exited the index since many funds and others will be trying to get out at the same time.

So wait, is throwaway2048 correct that this type of analysis misses companies who dropped out? Or are the gross return numbers including selling the shares of 'leaving the index' companies at a loss? I would imagine the latter and so his point is wrong, but I'm open to being corrected

Are you saying that there is a huge untapped arbitrage opportunity?

Nope, just that even if you do have data that captures when and at what price a company exited an index, you still wouldn't quite be able to work back to the performance of a tracking index fund (because you don't when and what price the index fund sold)

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