EXECUTIVE SUMMARY
The index effect refers to the excess returns putatively associated with a security being added to, or removed from, a headline index. Although it has been studied for decades, the index effect has received more attention in recent years amid the growth of passive investing and the accompanying speculation that stock returns may be affected by buying and selling pressures from index-tracking investors reacting to changes in index membership.
This paper analyzes S&P 500® additions and deletions from the start of 1995 to June 2021. We focus on the S&P 500 given it is the world’s most widely followed index—USD 13.5 trillion was indexed or benchmarked to the large-cap U.S. equity gauge at the end of 2020 —and so if the growth of passive investing contributed to an index effect, one might expect it to appear in S&P 500 additions and deletions.
Overall, our analysis corroborates the general consensus reflected in existing literature: the S&P 500 index effect seems to be in a structural decline (see Exhibit 1). Our analysis also suggests that an improvement in stock liquidity may help to explain the attenuation in the index effect over time.
