Front Running S&P 500 ETF Rebalances Could Be Adding to Tracking Errors | ETF Trends

Some savvy traders have taken advantage of scheduled rebalancing in popular exchange traded funds to front run potential changes, adding to wider divergence between S&P 500 ETF plays.

Year-to-date, the SPDR S&P 500 ETF (NYSEArca: SPY) rose 2.15%, iShares Core S&P 500 ETF (NYSEArca: IVV) gained 2.24% and Vanguard 500 Index (NYSEArca: VOO) increased 2.24%. [Not All S&P 500 ETFs are the Same]

“The differences could just be a matter of how they’re managing the stocks coming in and out of the index, or how they’re managing the cash that leaves the fund, but if they’re doing anything else they’re affecting the tracking error and that’s not what they’re being paid to do,” according to Paul Schatz, president of Heritage Capital, reports Jeff Benjamin for InvestmentNews.

With more money going into popular S&P 500 ETFs, some large traders are trying to front run or buy up shares of companies just before ETF providers make scheduled rebalances to their index funds.

For example, the markets knew that American Airlines Group (NYSE: AAL) would join the S&P 500 after markets closed on March 20. Consequently, traders had about four days to acquire AAL shares ahead of the major benchmark changes – index funds sparked an $8 billion buying spree, or the equivalent of over two weeks of the stocks’ typical volume, in the two minutes before the close. In the days prior to American Airlines Group joining the S&P 500, AAL shares jumped 11%.

The cost to S&P 500 investors could have added up to $4.3 billion per year in potentially lost returns. According to Winton Capital Management, front running stocks going into and coming out of indices may have cost investrs in S&P 500 ETFs at least 20 basis points over the course of a year.