Advertisement

A fund to gamble on index reshuffles

This fund uses arbitrage to take advantage of the inefficiencies created when financial indices rebalance. In other words, it buys firms due a promotion and sells those that are likely to be demoted.

Arbitrage sounds complicated, until you realise it often simply means buying an asset and selling it on to profit from short-term price differentials. Imagine you could import cars cheaper from Spain than you could sell them for in Britain: that's arbitrage. But if it's that easy, everyone should be doing it.

Advertisement - Article continues below

Which is one reason we're wary on Aviva Investors' new fund, based on arbitraging 'index rebalancing'. Here's how it works. Take the FTSE 100 index. It has a quarterly reshuffle. Each time a few stocks those whose market value has tumbled get relegated to the mid-cap index. In exchange, a few mid-caps get promoted. Passive funds (exchange-trade funds, index trackers and the like) are obliged to replicate the performance of the index. So every time a few firms get promoted into the top tier, those companies get heavily bought by the growing number of index funds. This "rapid growth in passive investment has also created greater anomalies in the marketplace", say Aviva. "Not only do passive investors by their nature allocate capital in proportion to the market capitalisation of existing companies suggesting an inefficient allocation of capital but the rebalancing of indices itself also creates inefficiencies prone to arbitrage."

That's where the Aviva Investors' Index Opportunity Fund (tel: 020-7809 6000) steps in. It looks to buy firms due a promotion to profit from the likely increase in share price following a rebalancing. It also sells those that are likely to be demoted. It repeats this trick for 25 indices across the world.

The fund's performance since launch in April has beaten the FTSE 100, as well as the targeted return of 5% above one-month Euribor (a key interbank interest rate). Aviva's Jerome Nunan tells the FT that cuts by banks and hedge funds mean that the "opportunities thrown up by index rebalancing were less likely to be arbitraged away". In other words, Aviva thinks its competition has dropped away.

So why are we wary? Professional arbitrageurs might be ignoring the strategy now, but that won't last forever, particularly if it works. And the fund isn't cheap: annual fees are around 2% and there's a 10% performance fee on returns above one-month Euribor, which seems a lot to pay for a simple strategy that surely can't sustain its outperformance.

Advertisement
Advertisement

Recommended

ESG investing provides shelter in the storm
Funds

ESG investing provides shelter in the storm

Funds focusing on environmental, social and governance (ESG) issues proved resilient during the market slump.
23 Jun 2020
Asian income stocks: where to find the continent's top money machines
Share tips

Asian income stocks: where to find the continent's top money machines

International dividends shouldn’t only mean companies in the US or Europe – the Far East has plenty of big payouts to offer. Cris Sholto Heaton looks …
22 Jun 2020
Could an ill wind hit renewable energy funds?
Renewables

Could an ill wind hit renewable energy funds?

Infrastructure is a good investment – but watch out for hidden risks, particularly in renewable energy.
9 Jun 2020
Precious metals will keep shining – buy these funds to take advantage
Gold

Precious metals will keep shining – buy these funds to take advantage

Data on volatility suggests that a V-shaped recovery may not happen, so hold gold or silver.
1 Jun 2020

Most Popular

Eagle Lightweight GT: the reincarnation of the E-type Jag
Toys and gadgets

Eagle Lightweight GT: the reincarnation of the E-type Jag

Jaguar’s classic E-type sports car has been reinvented for the modern age. The result – the Eagle Lightweight GT – is a thing of beauty.
7 Aug 2020
Platinum: the precious metal that looks set to play catch-up with silver and gold
Silver and other precious metals

Platinum: the precious metal that looks set to play catch-up with silver and gold

Gold and silver continue to soar, but there's still time to get in. And there's another precious metal that looks set to go on a bull run too, says Jo…
7 Aug 2020
UK house prices hit a new record high – can it last?
House prices

UK house prices hit a new record high – can it last?

Despite the pandemic, UK house prices have hit a new high. John Stepek looks at what’s driving the surge in prices, and what it means for house prices…
7 Aug 2020