The Active Side of Indexing

CFA Institute

Rob Arnott, Lillian Wu

Research

55 Pages

CFA Institute Research Foundation examines why index funds are not fully passive at the margins. The authors argue cap weighted indexes can quietly chase momentum, absorb reconstitution costs, and buy stocks after large price moves rather than before them.

Key Takeaways

Hidden Trading Costs: S&P 500 additions outperformed deletions by 12.21% from announcement to trade date, making zero tracking error look less costless.
Passive Scale Matters: In 2000, index funds held $0.4 trillion and 3% of US equities; by 2024, $13 trillion tracked the S&P 500 alone.
Better Selection Helps: The fundamental size portfolio outperformed the S&P 500 by 41 bps annually from October 1989 to June 2025, with identical turnover.
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