Joining and leaving an index: Those who decide, and those who are forgotten

We imagine an index calculates itself, by a formula. For many of them, that is not true.

The S and P five hundred is run by a committee. A few people who meet and decide who comes in, who goes out.

There are rules: a minimum size, profits, enough shares traded. But meeting the rules is not enough.

The committee has the final word. A company can tick every box and stay outside.

Why does it matter? Because trillions follow this index, automatically.

Say index funds managing one trillion. A company joins and weighs one per cent: they must buy ten billion of it.

All at the same time, on the same date, whatever the price. It is a buyer that does not negotiate.

Markets know this. Between the announcement and the entry, the price often rises, before the funds even buy.

That is the inclusion effect. And the reverse exists: a company that leaves sees the funds sell its shares all at once.

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The most spectacular example dates from two thousand twenty. Tesla.

In September, Tesla meets the criteria. The committee does not pick it. The share drops.

On the sixteenth of November, its entry is finally announced, for the twenty-first of December.

Between the two dates, the share gains almost seventy per cent. The funds buy at a high price.

It is the biggest entry in the index's history. Index funds had to buy tens of billions of dollars of shares.

Now, let's look at exits. And a very discreet trap: survivorship bias.

For the example: ten companies in nineteen ninety. Three go bankrupt. They leave the index.

If you study the index's companies today, you only see the seven survivors. The losers have vanished from the picture.

Your conclusion will look too good. Not because the market is generous, but because the failures were erased.

The Dow Jones of eighteen ninety-six had twelve stocks. The last one, General Electric, left it in two thousand eighteen.

The index carried on. It replaces losers with winners. That is its strength, and also what flatters its past.

For you as a saver, this renewal is good news: the index never stays stuck with the dead.

But be wary of lists of past champions. They only show those who survived.

An index is a club. With a doorman, a waiting list, and former members nobody mentions any more.