Take Advantage of Opportunities on Index Inclusion Date - Scotia Analyst

The days in and around the index inclusion dates for securities added to Canada's main indexes provide opportunities for active investors to shake up their portfolio, says a new report from Scotia Capital.

Darren McGrath wrote in a note to clients:

Active managers should take advantage of the extraordinary volume created by index events to initiate, add to, or exit from positions. The increased volume allows investors to trade larger positions with less market impact than normally predicted for such trades.

Mr. McGrath said that over the last seven quarterly rebalances, every stock added to the S&P/TSX Composite Index showed, on average during the five days surrounding the addition, a volume spike of 281% compared to the typical trade volume for the stock. Additions made to the S&P/TSX 60 Index over 2007 and 2008 year-to-date showed volume growth of 413% versus typical trade volume.  Stocks added to the MSCI Canada index also showed significant volume increases around the time of inclusion.

The analyst said the spike in volume could provide an exit point for active managers, particularly on the actual Index inclusion date. But, he also cautioned that fundamentals remain the "major driver for valuation" even during this period of pumped-up volume activity.

He wrote:

Trying to get cute about making a quick trade around the inclusion date can prove to be unsuccessful. The average return on the day of inclusion and day following was negative for stocks going into the 60. However, the Composite and MSCI changes seemed to show positive returns leading into the index change and negative returns the day after.

Mr. McGrath added that average prices were higher around inclusion dates than in the two months prior and also in relation to the overall market. But, he noted, the price trend is what made them eligible for inclusion in the first place.