A new Standard & Poor's study shows the pop that stocks get from being added to S&P indexes has shrunk steadily over time. Median excess returns between the announcement date and the date the stocks are added to the S&P 500 index decreased from 8.9% between mid-1998 and mid-2000, to 4.5% between mid-2000 and mid-2002, and to only 3.6% between mid-2002 and mid-2004. The same pattern is true for S&P midcap and small-cap indexes, the study found. Three structural issues lie behind the trend: growing awareness of the trend encouraged arbitrage activity; many index funds have begun to trade around the effective date, minimizing the cost of index changes; and a rise in small-cap and midcap indexed assets have offset the effect of additions to those indexes.
As a result, according to the study, profiting from index arbitrage will become harder; the index effect likely will never end but will settle at lower levels; and tactical asset allocation based on indexes will do better vs. broad-market indexing as the "wealth loss" from index changes declines.