If you are an investor in a passive index fund, exactly what happens to your equity when that fund/index removes a poor performer and replaces it with a stock that has recently performed much better?
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“If you are an investor in a passive index fund, exactly what happens to your equity when that fund/index removes a poor performer, and replaces it with a stock that has recently performed much better? While I suspect that your equity may stay the same upon replacement, it seems intuitively like an example of buying high while selling low. Is there any documented study of index fund performance over time due to the survival bias? Do you have any thoughts on the topic?” ~ Dom
I think I understand what you are saying but actually in this case the survival bias of the index methodology helps its performance over time, not hurts. What you are suggesting makes sense prima facie – that they are adding companies at high prices and removing others at low prices – but the fact of the matter is that the companies removed from the index is very rare, and almost always only happens after the company is broken. A significant amount of companies that have been removed from market indices over the years no longer exist at all, meaning that path from “a low price” to “zero” was never experienced by the index investor. Of course, there are cases when a company is removed from an index and subsequently rallies from a low valuation, but that is much less frequent than the opposite. And all of it is very rare and inconsequential …
Links mentioned in this episode: TheDCToday.com DividendCafe.com TheBahnsenGroup.com
David is the Founder, Managing Partner, and the Chief Investment Officer of The Bahnsen Group.
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