For active investors, the inclusion of CrowdStrike Holdings (CRWD), KKR (KKR), and GoDaddy (GDDY) in the S&P 500 index on June 24th presents a unique opportunity to potentially capitalize on a well-documented market phenomenon. These three stocks jumped in after-hours trading following the announcement on Friday, drawing the attention of market participants seeking to benefit from the short-term outperformance that often accompanies such index changes.
This phenomenon, known as the “index effect,” refers to the tendency of stocks added to a popular index like the S&P 500 to outperform the market between the announcement and effective dates, often followed by a minor correction post-inclusion. The temporary outperformance is primarily driven by increased demand from index funds and institutional investors who closely track the S&P 500 and adjust their holdings to mirror the index.
A recent example came this March when it was announced that Super Micro Computer (SMCI) and Deckers Outdoor (DECK) would be joining the S&P 500. On the day of the announcement, Super Micro (the AI server, software and infrastructure company) was up more than 25% during the session while DECK, the footwear and apparel company best known for Uggs and Teva brands was up 2.6% on the announcement. The difference between the growth prospects for general AI and shoes reflects the difference in pop in stock prices. Nevertheless, these returns were greater than what the S&P 500 saw on those days.
The growth of passive investing through index-linked investment products and exchange-traded funds (ETFs) has been remarkable over the past five decades. The S&P 500 has become a particularly attractive benchmark for passive investors due to its low turnover and long-term investment approach, with an average of only 25 changes annually, representing about 5 percent of the total number of stocks. For most passive investors, an ETF tracking the S&P 500 makes good sense, as it provides broad exposure to the U.S. stock market and has historically delivered solid returns.
However, active managers argue that the rigid investment mandate of passive index funds may cause investors to miss out on opportunities that arise from changing market conditions. By conducting thorough research and analysis, active managers can identify undervalued companies with strong growth potential and construct a portfolio tailored to their investment objectives and risk tolerance. This flexibility to adapt and capitalize on market inefficiencies may give active management an edge over passive index funds in the long run.
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