A company added to a widely tracked index sees its shares bought by funds that have no discretion in the matter. The demand is mechanical, dated in advance, and visible to everyone.
Tracking funds have no choice
A fund that promises to replicate an index must hold what the index holds, in the stated proportions, from the effective date.
The decision to buy is therefore not an assessment of the company. It follows from the fund's mandate and would be a breach to ignore.
Because a substantial share of equity assets is managed against major indices, the aggregate size of that obligation can be large relative to the company's tradeable shares.
The date is known and the demand is concentrated
Index providers announce changes in advance, so the market knows which shares must be bought and when.
Funds concentrate their trading around the effective date, because tracking error is measured against the index and buying early creates a deviation.
The combination of a known date and a large obligation is unusual in markets, where most demand is neither announced nor compulsory.
Anticipation moves the price first
Other participants buy in advance, expecting to sell into the compulsory demand, which pushes the price up before the funds have traded.
Tracking funds therefore buy at a higher price than existed before the announcement, and the difference is a cost borne by the fund's investors.
Part of that rise commonly reverses in the weeks afterwards, once the forced buying has been absorbed and the anticipatory positions unwind.
Removals work the same way in reverse
A share leaving an index must be sold by the same funds on the same date, producing concentrated supply and downward pressure.
The effect can be sharper on removal because the shares involved are often already under pressure and less liquid, so the selling meets thinner demand.
Deletions also lose ongoing passive ownership, which removes a source of stable demand for as long as the share remains outside the index.
Why providers have changed how they manage it
Index providers have adjusted rules to reduce predictability, including phasing large changes and using buffer zones so shares near a boundary do not move in and out repeatedly.
Funds have responded by trading around the effective date rather than at it, accepting slightly higher tracking error in exchange for better prices.
The underlying tension persists, because an index that is transparent enough to be tracked is also transparent enough to be anticipated.