Should We Rebalance Index Changes Immediately?

30.August 2022

Passive index funds are believed to offer low fees, nearly limitless liquidity, very low trading costs and (most of the time) they beat most active managers. Although not all of the above are accurate, there are still many arguments in favour of passive indexing. However, what is often left forgotten are avoidable travails linked to index funds. In general, after an index rebalances, traditional cap-weighted index funds buy high and sell low. Their tendency to add recent highfliers and drop unloved value stocks is what causes investors to lose. Arnott et al. (2022) target the stock selection problem around index rebalancing and propose several ideas on how to adjust index strategies in order to earn above-market returns. They present simple ways to construct an index, thanks to which it is possible to reduce both negative effects of buy-high/sell-low dynamic and the turnover costs of cap-weighted indices.

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Takeover Factor Explains the Size Effect

18.July 2022

The size effect assumes a negative relationship between average stock returns and firm size. In other words, it states that low capitalization stocks outperform stocks with large capitalization. Although generally accepted, the size effect keeps being challenged. Researchers have been asking how important the firm size characteristic actually is, and whether it is possible to replace the traditional size factor of Fama and French asset pricing model (1993) with more accurate factor. Recently, one potential challenger has emerged – so-called takeover factor, employed by Easterwood et al. (2022). In their study, they work on the assumption that small firms are often targets of takeovers, which gives us a different perspective on merger and acquisition news in regards to size effect. Their results show that M&A component of average returns explains the size premium entirely.

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