Why Rebalancing Can Drag an ETFs Performance

Yeah, the topic I wanted to bring up uh with IWM specifically is the reconstitution or rebalancing strategy that it uses.

Uh it's it creates a potential drag for investor returns based on how it works.

It essentially rebalances once a year in June, although I think that's switching to twice annually starting next year.

But it essentially announces the companies that are going to get added and deleted about a month ahead of time.

So if you're an arbitrageer or a trader, you know, you you start seeing some of that front running.

These companies are getting added, they tend to outperform in the leadup and then they fall back once they're added.

And then the opposite happens with the deletions as well.

So um if if you look historically there are studies out there that say that that creates like a you know 20 to 50 basis point performance drag on the index just because of uh some of that coming and going that happens around the rebalance.

So, um, it does tend to have a material effect, if not necessarily a major effect, but, uh, VXF and all the all the funds that are tied to the S&P indexes, uh, they tend to use more of a a rolling addition and deletion strategy.

So, there's no there's no single reconstitution day.

It's sort of, uh, adding and deleting little by little as the year goes on.

So you don't necessarily have some of that front running or some of that you know big change in in trading or liquidity that happens just around a single day.

So uh this is more of a structural issue than anything.

But uh I'll call the winner in this category VXF just because you don't have that uh you know big buy and dump uh s just coming around one day for the index.

You have it sort of spread out little by little throughout the year.

And I think that's better for uh investor efficiencies.