Passive in a Name - Evidence from MSCI China Index and MSCI China Index-Tracking Fund

Abstract

Abstract: Traditional research about the passive investors and index were mainly focus on the tracking error and the performance of mutual funds. However, they ignored that, deceptive by name, the passive investors, such as index-tracking funds and ETFs, may have an active impact on the value of the company through large-scale transactions of these passive investors. Focused on the Chinese stock market, this paper investigates whether specific passive investors, the funds and ETFs that track MSCI China index, will actively influence the market valuation after MSCI Index Rebalance. When the passive shareholders, which are always the mutual funds, exceeds a threshold, I find that firms added to the index will have a significant positive return, about X%, to the index itself. Also, I find the firms eliminated out to the index have a significant negative return, about X%, to the index itself. One potential interpretation of these results is that index-rebalancing will lead the index-trackers to buy those stocks added to the index, and these transactions represent a large buy power that will lead the demanding of those stocks to exceed the selling power and this dynamic of trading plus the following transactions of other investors eventually cause a premium and positive return. The firm size will also have an impact on stock performance when the index get rebalanced, partially in that the weight of the index is calculated according to the market value, a calculate method that leads to the higher weight of large companies. If large companies are added to or removed from the index, the trading volume will be larger, causing more transactions dynamic on those stocks.