The Effect of Inclusion in Exchange-Traded Funds: An Empirical Analysis Using U.S.-listed Stocks and the Annual Russell Reconstitution

Abstract

This analysis investigates the effect of Exchange-traded Fund (ETF) addition and deletion on the price and volume of U.S.-listed stocks. Motivated by the persistent growth in the number and assets managed by ETFs, as well as their low-cost and accessibility to retail investors, the annual constituent changes of the members of the Russell 2000 index are evaluated through their replication in the BlackRock iShares Russell 2000 ETF (IWM). Using the exogenous variation created by the methodical constituent changes of the annual Russell reconstitution for the years 2012 through 2017, this analysis uses differences-in-differences fixed effect regression analysis to investigate and interpret the effect of a stock’s addition or deletion from an ETF. Analyzing a time period of -/+1 day and -/+10 days surrounding each year’s reconstitution, deleted stocks are associated with negative price effects before reconstitution and temporary positive price effects after the annual reconstitution. Added stocks are associated with positive price effects before reconstitution and temporary negative price effects after the annual reconstitution. Furthermore, the volume effect of ETF addition and deletion is strong and positive in the pre-reconstitution period, but is significantly reduced in the post-reconstitution period.