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.

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."

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Theo Casey

Theo is a former financial writer and editor, having written for reputable titles such as Euromoney Institutional Investor and Redwood Publishing. He has also appeared on-screen with Al Jazeera, BBC and CNBC and on MoneyWeek Theo covered funds, share tips and stockmarkets. He also edited the country's oldest newsletter with Lord Rees-Mogg for four years. Theo now runs his own content marketing agency for financial companies, and he is a seasoned CISI-qualified investment adviser.