Index reconstitutions can be decided either by rules or by a committee. Which way has less transaction cost?
In schweser notes Book3, Page 139. reconstitution by committee- less transaction costs
same book, page 203, reconstitution by committee-additional transaction costs?
Any comments please? Thanks.
What’s the curriculum say?
I believe the rules-based index will have less transaction costs because PM’s are able to anticipate changes in the index before they actually happen.
If the index is reconstituted based on a committee vote then you have absolutely no way of knowing what will be added or removed. Look at the historical changes to the DJIA. Its components are decided by the editors of the WSJ. Citi and GM were dropped from the index after their fall from grace in 2008. Any index mirroring the DJIA would have needed to sell its Citi and GM exposure and add the new components.
You want an index that has a transparent process for removing and replacing index components so that you will be able to trade accordingly.
that’s a very good point. Scheweser notes was comparing this two in terms of frequency, so which one is more frequent, high turnover? Thanks.
Less frequent, but also less transparent.
Also committee ones may drift from their intended purpose if not done frequently enough
If it is super popular and liquid like s&p 500 then liquidity trumps lack of objectivity