Hi all,
I was reading up on special situations strategies and came across index inclusions. Do any PM's/Analysts have time to shed some light on how to predict/capitalize on a stock entering or being removed from an index as a source of alpha?
Much apreciated,
MM
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I am interested too.
Do some of the indexes publicly disclose their inclusion criteria?
Yes all major indices do. Just Google the index name followed by "methodology"
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i see you everywhere, incoming freshman aswell you make me look like a true retard. bright future ahead for you, keep it up
I think one of the main situations where this happens is with spinoffs. So if a company on the S&P 500 spins off a part of itself, and that company is too small for the index, all the ETFs holding shares of both companies will be forced to sell the spinoff. That pushes the price down, creating a nice value play. In practice, spinoffs don't happen that often, so the opportunity set isn't that large but at least it's predictable.
I also found Baupost/Klarman very impressive when I was in college but in the real world, his rigid framework means he hasn't been able to deploy capital effectively since GFC.
The forced selling/buying sounds very cute but it rarely results in a massive dislocation these days. The index funds are selling their position in the 3 weeks leading up to the actual date (more weighted toward last week). This can often provide an opportunity for a sizable LO to scale up their position in size and effectively cancel out the impact of forced selling.
Boy I think I just found your tiktok you got the same name on there
Normally the dates are known in advance and you can replicate the selection criteria to predict what the index may look like. More and more indices are using phased rebalance periods now so the volume doesn't spike and it is a gradual shift. Events such as spin-offs and m&a can also create opportunities with how they are handled in the index.
"phased rebalancing period"?
Would be happy to know which indices are using that, never heard of it
https://amp.ft.com/content/f916d132-0f86-4e0e-a3fa-6a80fdf6e40c
Tbh never heard of the firm in the article, but they aren't the only ones using a phased approach.
This guy had a pretty accurate strategy lol...
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this is what is happened with moderna and alexion pharma. i also wonder how much alpha the firms already using this strategies have generated. Really exciting stuff !
If anyone is interested in Index arbitrage or predicting index flows/additions/deletions, please reach out to me.
Currently work for a large investment bank on the east coast and we are hiring junior roles or with a year of experience. Would love to chat.
Thanks!
Hello,
i worked 3 years at an event driven fund si can give a bit of info.
The basic idea is that ETFs tracking an index will have to buy the stock that will be included inside the index to be able to replicate the index performance. Hence there will be a lot a buying flows on this stock, that should generate excess returns. If you can forecast the future inclusions, you can buy the stock before the ETFs and make profit. Apply the reverse logic for stocks being deleted from the index.
Happy to go more into details if u have more questions
How much does a stock go up / down post index inclusion / deletion? What kinds of returns are you targeting for this trade (would prefer if you could share absolute basis, but IRR / annualized works too)
One example Diameter talked about in their Bloomberg interview was buying Netflix bonds in anticipation of a credit rating bump which would allow IG funds and indexes to add their credits.
It's a pretty mature risk premium strategy that is correlated to passive equity inflows. You can think of it as merger arb like with risk spreads on names.
Outside of Commodities, it was the top performing hedge fund strategy of 2021, i think.
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