On a late Friday afternoon in June 2018, the S&P Index Committee announced it was adding Fleetcor Technologies to the S&P 500. On Monday, Fleetcor jumped 6.45% even as the rest of the market dropped. But a week later, Fleetcor was back to its pre-S&P 500 price. That spike in stock price after an announcement that the stock will join a popular benchmark is known as the index inclusion effect, but an article in Morningstar points to recent evidence that the effect has evaporated in the last 10 years.
While Fleetcor’s June 2018 meteoric rise then fall was a classic example of the effect, research from Standard & Poor’s shows that while the effect was pronounced in the mid-to-late 90s as well as the 2000-10 decade, it all but disappeared in the the 2011-20 decade. Instead of the up-and-down path new index additions usually take, it’s now a flat line running from the date of announcement through several weeks following inclusion.
Improved market liquidity may partially explain the index inclusion effect’s decline; many new S&P 500 additions come from small S&P benchmarks, which have all grown at a rapid pace in the last 20 years, the article notes. But not every S&P 500 company gets into the index by promoting from a smaller one. Some companies may have been large enough, but didn’t meet the float, liquidity or profitability requirements. And those companies often do show the index inclusion effect after they join, with a notable example being Tesla. When its inclusion in the S&P 500 was announced in late 2020, its share price skyrocketed over 70% over the next month. To make room for Tesla, Apartment Investment & Management was yanked from the index and dropped 0.69% in the same month. Then, Tesla officially joined the benchmark and fell 7.86% in the next 2 days, while Apartment Investment jumped 12.39%.
Still, the index inclusion effect isn’t necessarily easy to capitalize on for investors. Stocks that are dropped from the index aren’t guaranteed to rally; when Foot Locker was removed in August 2019, it fell 21.1% through March of this year. Accurately timing trades is tricky. To protect against the effect, the article advises buying index funds that span the whole market instead of sticking separate ones together that represent large-cap, small-cap, mid-cap, and value-to-growth dimensions. Having less “seams” in your index fund portfolio can prevent leaks. The article highlights the Vanguard Total Stock Market ETF as a good example of a “seamless fund.” Though investors shouldn’t be too focused on avoiding the index inclusion effect, buying broader funds will help ease those concerns.