I've seen plenty of tweets/posts that these two companies now meet the criteria for joining the S&P500. So my question was, what does this mean for these companies and their respective share prices? All of these tweets were positive in nature and implied expectations of a share price increase, which caught me by surprise.
As a long-term investor, I couldn't see any rationale that this leads to higher valuation. The companies will continue operating the exact same way as they did in the past and I don't think anyone adds a premium because a company is part of the S&P500 (and rightfully so).
But then I noticed that I was looking at all of this from a different angle. I should look at this as a trader, someone who wants to exploit the short-term price movement due to changes in sentiment and demand/supply.
So, my rationale was as follows: In an event of this kind, there should be a higher price (temporarily) because the demand increases due to:
– Increased analyst coverage
– Increased ownership by institutions (i.e. index funds)
– Increased liquidity
So the question that I had wasn't so much if this happens, but when does it happen? I identified 5 potential time points:
- Before the criteria for S&P500 inclusion are met
- When the criteria for S&P500 are met
- When the inclusion is announced
- Days before the inclusion
- Days after the inclusion
I am not the first one asking this question, as there have been plenty of studies, the first one dating back to 1986. So, I read over 350 pages of relevant studies to understand the past research and see how the conclusions changed over time. I won't bother you with all the studies, as this post is getting quite long anyway. Here's my attempt to summarize what I've read.
The research papers before the year 2000 point out an abnormal return of around 3% on the inclusion announcement, as well as the inclusion day. This is definitely not a bad return for one day.
The reason why “abnormal return” is being calculated, is because there could be other macro events happening around the same time (such as the FED raising/decreasing interest rates). To eliminate this effect, the difference between the share price of the company & the index is being used as a calculation for “abnormal return”.
As time goes by, there is more cherry-picking involved. Instead of pinpointing to a single day, studies point out abnormal returns happening over a month, or even 50 days. This, in my opinion, is the result of cherry-picking data, to find the right timeframe that supports the hypothesis.
Fast forward to 2018, the narrative changed to “The inclusion effect seems to be disappearing”. A study divides the companies that went public into groups (group 1 between 1995 and 2000, followed by group 2 between 2001 and 2004, and so on).
Between 1995 and 2000, there was almost 7% abnormal return 10 days prior to inclusion, and a 3% decrease in the 10 days that followed. Over time, this effect was reduced, and after 2015, during the same period, there was a decrease of 1% and another 1% respectively.
The latest research done in 2023 had the summary “The S&P index effect has disappeared” testing out different timeframes:
- Before & after the announcement
- Between announcement & inclusion day
- Before & after the inclusion date
The conclusion was that there was no significant abnormal return over the last decade.
So, is the conclusion that there's no price impact? Not really. Over the last 3 decades, the price change from 100 days prior to the announcement to 20 days after that was almost the same. However, in the past, there was a moment of time when the price changed. Over the last decade, that wasn't the case.
That means, as everybody is trying to outsmart the rest, by buying before D-day, they're moving the impact earlier, and earlier, and earlier. The market became more efficient.
Therefore, the index inclusion effect is already priced in. If anything, there should be a slight reversal for both companies in the coming period.
I hope you enjoyed the post!
Leave a Reply