ETF expense ratios are only the headline cost. There's also a hidden cost you never see.
An index (and, therefore, any fund that tracks it) has a methodology that results in additions/deletions/index changes being announced to the market ahead of time. Usually that's quarterly, but also sometimes annually.
For an index addition announcement, you can imagine that the price will go up beforehand, since market participants (all except the actual ETF) will buy the stock in anticipation of the extra demand of that stock being in a widely held index. [This is actually more complex, and doesn't always work in that direction, but that's beyond the scope of this comment].
Now, the ETF doesn't care about this. They get graded on how closely they track the index. So they will buy the index addition on the closing auction of the day of the index reconstitution. Sure, they'll get a worse price (on average) than if they had bought 2 weeks ago, but who cares? They don't, and their clients don't (partly because they don't know).
This effect is even more pronounced in certain indexes where this dislocation would be larger, e.g. those with more turnover, infrequent rebalances, etc.
Just drop "what is the drag on returns due to index reconstitution in the Russell 1000 index?" in ChatGPT. Admittedly that's one of the worst offenders, and this is not scientific, but ChatGPT says 0.2% to 0.3% annually. That's already more than the 0.17% average mentioned in the original posting.
[Source: I worked on the trading floor in the program trading desk of a bulge bracket bank that actively traded these index reconstitutions.]
ETF expense ratios are only the headline cost. There's also a hidden cost you never see.
An index (and, therefore, any fund that tracks it) has a methodology that results in additions/deletions/index changes being announced to the market ahead of time. Usually that's quarterly, but also sometimes annually.
For an index addition announcement, you can imagine that the price will go up beforehand, since market participants (all except the actual ETF) will buy the stock in anticipation of the extra demand of that stock being in a widely held index. [This is actually more complex, and doesn't always work in that direction, but that's beyond the scope of this comment].
Now, the ETF doesn't care about this. They get graded on how closely they track the index. So they will buy the index addition on the closing auction of the day of the index reconstitution. Sure, they'll get a worse price (on average) than if they had bought 2 weeks ago, but who cares? They don't, and their clients don't (partly because they don't know).
This effect is even more pronounced in certain indexes where this dislocation would be larger, e.g. those with more turnover, infrequent rebalances, etc.
Just drop "what is the drag on returns due to index reconstitution in the Russell 1000 index?" in ChatGPT. Admittedly that's one of the worst offenders, and this is not scientific, but ChatGPT says 0.2% to 0.3% annually. That's already more than the 0.17% average mentioned in the original posting.
[Source: I worked on the trading floor in the program trading desk of a bulge bracket bank that actively traded these index reconstitutions.]