ETF Trends
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.

Antti Petjusto, a money manager at BlackRock, has argued that the estimated indirect impact could raise the actual expense of an index fund by 28 basis points. To put this in perspective, VOO has a 0.05% expense ratio, IVV has a 0.07% expense ratio and SPY has a 0.09% expense ratio.

Nevertheless, some fund providers are trying to mitigate the risk of front running. For instance, Vanguard Group tries to gradually build up positions over time if stocks are scheduled to be added, according to Doug Yones, Vanguard’s head of domestic equity indexing and ETF product management.

“It just comes down to being smart with your trades,” Yones said in the article. “It’s a big enough deal that index managers are aware and spend time and energy making sure there isn’t an impact.”

For more information on the S&P 500, visit our S&P 500 category.

Max Chen contributed to this article.

Full disclosure: Tom Lydon’s clients own shares of IVV and SPY.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.