As previously highlighted, index rebalancing days are known for significantly larger closing auctions. This phenomenon occurs because index funds generally align their holdings with changes made by their index providers, which use official closing prices for their calculations. Typically, a closing auction accounts for less than 10% of the day’s trading volume, while certain index rebalance days see this figure rise above 30%.
Analyzing the scale of closing trades on index addition days can offer insights into total index fund tracking. Findings suggest that on such days, companies could see up to a quarter of their float shares purchased by index funds. Being added to major indexes is favorable for companies, as it attracts substantial new, often long-term, investors.
Historically, index rebalancing days result in unusually high closing volumes. As illustrated in related charts, major index trades occur on specific dates. For example, MSCI typically rebalances at the end of May and November, whereas S&P, Nasdaq, and FTSE indices adjust on the third Friday of the quarter’s final month, coinciding with “quad witching” and thus boosting close volumes. The Russell indices are rebalanced annually, usually on the last Friday in June that does not fall on a quarter-end.
A typical market close entails approximately $40 billion in trading, less than 10% of the entire day’s volume. Conversely, S&P and Russell index days witness average close trades reaching $240 billion, constituting over 30% of the day’s closing volume. Even MSCI rebalancings elevate close volumes to about 20% of average daily volume.
There are two primary methods to estimate how much index tracking affects trading activity. The “top-down” approach involves using disclosures from index providers and academic research to understand trackable funds, while the “bottom-up” approach observes actual trading volumes on rebalance days to gauge index fund activity. Employing the “bottom-up” method, it was discovered that on rebalance days, a significant portion of small caps, such as 27% in the S&P 600 and Russell 2000, are influenced by index tracking. Despite the larger financial weight towards the S&P 500, in terms of company float shares, index influence tends to be consistent across all included entities.
Neither estimation method is flawless. Complex factors such as futures, options hedging, and potential pre-positioning by funds can skew results, as can behavior resembling “closet indexing” by active funds.
Off-exchange trading plays a growing role, especially in close trades, where echo prints mimic official close prices and contribute significantly to trading volumes, both on typical and index rebalance trading days.
Overall, on index rebalance days, the volume of trading tied to these activities far exceeds typical close trading. Index additions dramatically alter trading volumes for the affected stocks, emphasizing the importance of these changes for companies involved. Index inclusion attracts a robust, long-term investor base, enhancing exposure to U.S. capital markets.
Lastly, index inclusion often benefits companies significantly by increasing liquidity and attracting interest from active mutual funds, potentially facilitating greater access to investment capital in the U.S. market.
