This Friday, the JSE runs its quarterly index rebalancing. If you hold any ETF that tracks a local index, something is about to happen inside your ETF, probably without you noticing. That’s fine. But it’s worth understanding what’s going on.
What is index rebalancing?
Indices like the FTSE/JSE Top 40 or the All Share don’t stay fixed. Companies grow, shrink, list, and delist. To keep the index representative, the index provider reviews the constituent companies on a regular schedule. The March review is one of four quarterly check-ups.
The review looks at things like market cap, free float, and liquidity. Companies that no longer qualify drop out. Companies that have grown large enough to meet the threshold get added. Changes take effect on the third Friday of the review month.
What happens to your ETF?
ETFs that track these indices are passive. They’re supposed to hold exactly what the index holds, in the same proportions. When the index changes, the ETF has to match.
That means the fund manager buys the incoming stocks and sells the outgoing ones, all on the same day the change takes effect. If a stock is added to the Top 40, every ETF tracking that index is buying it simultaneously. If one is removed, they’re all selling at the same time. You can imagine what this does to the share price on rebalancing day. Added stocks often get a brief bump, removed ones a dip.
Traders know this, which is why you sometimes see price action ahead of the rebalancing date, not just on it.
How does the JSE compare to global indices?
This is where it gets interesting, different indices rebalance very differently.
The S&P 500 works on a similar quarterly and is also market-cap weighted as is the Top40 index. The bigger the company, the bigger its slice of the index.
The Dow Jones Industrial Average is a different beast entirely. It’s one of the oldest indices in the world, and it’s price-weighted — meaning a higher share price gives a stock a bigger slice of the index, regardless of company size. It only holds 30 stocks, and changes are rare and committee-driven, not scheduled. There’s no quarterly calendar. When Dow Jones adds or removes a stock, it’s making an editorial call, not following a formula. Changes happen maybe once or twice a year, if that, which makes Dow ETFs far less interesting from a rebalancing perspective.
Should you do anything?
No. The rebalancing happens inside the ETF, you don’t need to do anything. That’s the whole point of passive investing. Your fund manager handles the changes automatically.
This Friday’s rebalancing is routine. But understanding the mechanics helps you know what your ETF is actually doing under the hood and why index ETFs aren’t quite as passive as they appear.
ETF blog
At Just One Lap, we are big fans of passive investment using ETFs. In this weekly blog, we discuss ETFs on the local market and the factors you need to consider when choosing an ETF. If you have wondered how one ETF differs from another, this is where you can find out. We explain which index each ETF tracks, what type of portfolio could benefit from holding each ETF, and how the costs will affect your bottom line.
