Editing Index fund (section)

===Losses to arbitrageurs===
Index funds must periodically "rebalance" or adjust their portfolios to match the new prices and [[market capitalization]] of the underlying securities in the [[stock index|stock or other index]]es that they track.<ref name=BloombergFA>{{cite news|title=High-Frequency Firms Tripled Trades in Stock Rout, Wedbush Says|url=http://www.fa-mag.com/news/high-frequency-firms-tripled-trades-in-stock-rout-wedbush-says-8030.html|access-date=26 March 2013|newspaper=Bloomberg/Financial Advisor|date=August 12, 2011}}</ref><ref>{{cite news|last=Siedle|first=Ted|title=Americans Want More Social Security, Not Less|url=https://www.forbes.com/sites/edwardsiedle/2013/03/25/americans-want-more-social-security-not-less-let-them-buy-it/|access-date=26 March 2013|newspaper=Forbes|date=March 25, 2013}}</ref> This allows [[algorithmic trading|algorithmic traders]] (80% of the trades of whom involve the top 20% most popular securities<ref name=BloombergFA/>) to perform [[index arbitrage]] by anticipating and trading ahead of [[Market impact|stock price movements]] caused by mutual fund rebalancing, making a profit on foreknowledge of the large institutional block orders.<ref name=AmeryRebalancing>{{cite news|last=Amery|first=Paul|title=Know Your Enemy|url=http://www.indexuniverse.eu/europe/opinion-and-analysis/7634-know-your-enemy.html?showall=&fullart=1&start=2|access-date=26 March 2013|newspaper=IndexUniverse.eu|date=November 11, 2010}}</ref><ref>{{cite news|last=Salmon|first=Felix|title=What's driving the Total Return ETF?|url=http://blogs.reuters.com/felix-salmon/2012/07/18/whats-driving-the-total-return-etf/|archive-url=https://web.archive.org/web/20120720041358/http://blogs.reuters.com/felix-salmon/2012/07/18/whats-driving-the-total-return-etf/|url-status=dead|archive-date=July 20, 2012|access-date=26 March 2013|newspaper=Reuters|date=July 18, 2012}}</ref> This results in profits transferred from investors to algorithmic traders, estimated to be at least 21 to 28 [[basis point]]s annually for [[S&P 500]] index funds, and at least 38 to 77 basis points per year for [[Russell 2000]] funds.<ref name=Petajisto>{{cite journal|last=Petajisto|first=Antti|title=The index premium and its hidden cost for index funds|journal=Journal of Empirical Finance|year=2011|volume=18|issue=2|pages=271–288|doi=10.1016/j.jempfin.2010.10.002|url=http://www.petajisto.net/papers/petajisto%202011%20jef%20-%20hidden%20cost%20for%20index%20funds.pdf|access-date=26 March 2013}}</ref> In effect, an index, and consequently, all funds tracking an index are announcing ahead of time the trades that they are planning to make, allowing value to be siphoned by [[arbitrage]]urs, in a legal practice known as "index front running".<ref>{{cite web |url=http://www.thetradenews.com/1578 |title=Understanding index front running |access-date=2009-03-24 |work=The Trade Magazine |publisher=The TRADE Ltd. |archive-url=https://web.archive.org/web/20081023004716/http://www.thetradenews.com/1578 |archive-date=2008-10-23 |url-status=dead }}</ref><ref>{{Cite news|url=https://www.bloomberg.com/news/articles/2015-07-07/the-hugely-profitable-wholly-legal-way-to-game-the-stock-market|title=The Hugely Profitable, Wholly Legal Way to Game the Stock Market|newspaper=Bloomberg.com|date=7 July 2015}}</ref> Algorithmic [[high-frequency traders]] all have advanced access to the index re-balancing information, and spend large sums on fast technology to compete against each other to be the first—often by a few microseconds—to make these arbitrages. {{Dubious |reason=I don't think this particular arbitrage opportunity needs particularly fast technology, especially compared to other HFT algos|date=October 2016}} Losses to arbitrageurs appear as "tracking error", the difference between the performance of the index and the fund which is attempting to follow it.

John Montgomery of [[Bridgeway Capital Management]] says that the resulting "poor investor returns" from trading ahead of mutual funds is "the elephant in the room" that "shockingly, people are not talking about."<ref name=Montgomery>{{cite news|last=Rekenthaler|first=John|title=The Weighting Game, and Other Puzzles of Indexing|url=http://www.crsp.com/images/Reprint_Feb_Mar11MornignstarConversation_color.pdf|access-date=26 March 2013|newspaper=Morningstar Advisor|date=February–March 2011|pages=52–56|url-status=dead|archive-url=https://web.archive.org/web/20130729192302/http://www.crsp.com/images/Reprint_Feb_Mar11MornignstarConversation_color.pdf|archive-date=29 July 2013}}</ref> Related "time zone arbitrage" against mutual funds and their underlying securities traded on overseas markets is likely "damaging to financial integration between the United States, Asia and Europe."<ref>{{cite book|last=Donnelly|first=Katelyn Rae|author2=Edward Tower|title=Challenges and Opportunities for Trade and Financial Integration in Asia and the Pacific|publisher=United Nations Economic and Social Commission for Asia and the Pacific|year=2009|pages=134–165|chapter=Chapter VIII. Time-zone arbitrage in United States mutual funds: Damaging to financial integration between the United States, Asia and Europe?|chapter-url=http://www.unescap.org/tid/publication/tipub2563_chap8.pdf|series=Studies in Trade and Investment 67|location=New York|issn=1020-3516}}</ref>