The Hidden Costs Paid By Investors While Passively Tracking A Benchmark Index


Wednesday, March 28, 2018  03.10PM / SolactiveAG 

Today, Solactive AG published a new research paper analyzing the additional cost paid by investors in order to passively track a benchmark. The selection of an index as a benchmark has been tied to the cheap cost to reference it; however, in this research paper, Solactive AG quantifies the additional turnover costs that investors implicitly pay due to arbitrage activity - days before a transparent rebalancing takes place when many assets are tracking the index. 


In most cases, it turns out that the additional turnover costs can be as high as the price to track the index.


Timo Pfeiffer, Head of Research at Solactive, commented: “Since passive investing is based on rules involving the periodic buying and selling of securities as they are added or removed from a certain index, arbitrageurs can foresee these changes and act upon them. Any price shocks resulting from arbitrage are passed over to investors in the form of implicit costs. It is thus important to evaluate the impact of these inefficiencies and see what can be done to reduce them.”


Using a Eurozone blue chip index, the paper finds turnover costs are significantly larger than zero. In addition, the paper discusses how turnover costs can be decreased. The suggested measures include 1) having multiple indices in the same geography and mar- ket, 2) reducing the index turnover by adding turnover constraints into the index crea- tion’s methodology and 3) implementing a transparent rebalancing procedure with a long buffer time before the rebalancing date.


The publication of Index Turnover Costs follows the release of When Size Doesn’t Mat- ter: Equal Weighting vs. Market Cap Weighting and The Downside of Low Volatility ear- lier this year and is part of a growing collection of research papers published by Solactive AG.


To access the white paper, please click here. To find out more about Solactive Research, please click  here.


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