Index providers were thrown into the spotlight last month after a number of major players made the decision to delay their regular rebalances amid the market turmoil.
S&P Dow Jones Indices (SPDJI), FTSE Russell and ICE Data Services all made the decision to postpone updates to indices.
SPDJI was the first to pull the trigger by announcing to clients in a note seen by ETF Stream that all equity indices scheduled to carry out a quarterly rebalance before 23 March was postponed. Nasdaq followed suit by moving the majority of its equity rebalances to June.
ICE Data Services subsequently delayed the monthly rebalancing to its bond benchmarks in a move that impacts over 5,000 indices and around $77trn of global debt.
FTSE Russell has also made a number of postponements including the decision to split the final steps of the initial phase of including China A-Shares in its global benchmarks with the final to take place in June instead.
The London Stock Exchange Group-owned index provider then delayed rebalances for its fixed income indices that were due to take place at the end of the month.
Some hedge funds were impacted as a result. According to Forbes, firms front-running the scheduled rebalances were caught offside after the computer-driven algorithms spent weeks building positions in anticipation for the changes.
While the index providers explain the decisions reduce the risk to market participants, they have been questioned by some parts of the ETF ecosystem with some concerned about the lack of details provided while others suggested this is an area regulators should be looking at.
However, there a number of reasons why index providers were right to postpone the rebalance amid the market turbulence.
Firstly, it is important to understand the impact any rebalance can have on individual companies. Numerous academic studies have shown stocks suffer price drops when removed from an index. Chang, Hong and Lskovich, for example, found companies saw price increases when added to the Russell 2000 while deletions from the index saw price declines.
With stocks suffering their worst falls since the Global Financial Crisis (GFC) in 2008, any rebalance would have been based on irrational market fears rather than regular performance while any deletion could exacerbate the problems for companies dealing with the coronavirus pandemic.
Furthermore, some ETF issuers have highlighted the potential costs involved of making the changes during volatile markets
As Chris Mellor, head of ETF equity product development, EMEA, at Invesco, says: “This appears to be a sensible move as applying an index rebalance in a volatile market is likely to incur greater rebalance costs than under normal market conditions.”
However, some have argued this highlights the power the index providers wield and while this may become an issue as the ETF industry continues to grow, it also highlights a nimble set of firms reacting to the environment around them.
As long as the decision is made in the best interests of clients and stakeholders, the rebalance postponements should be viewed as a positive move from index providers looking to get on the front foot in addressing the problems that have arisen from this pandemic.
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