16 Comments

Wow, surprising indeed. This is one of these topics about which when noobs ask me, all I can do is shrug. Not no more, tho!

One wonders what this implies. Can I assume that all this easy issuance with a reliable buyer effectively lowers to cost of capital? If so, then this could be a positive feedback loop explaining some of the U.S.'s stock market strength (until the point where it turns into a circulus vitiosus).

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One of the great unspokens is that buybacks are more tax efficient for individual investors than dividends. Even in the light of Klement's findings that new issuance offsets buybacks over the long haul, buybacks prevent dilution, so one can realistically expect share prices to inflate with earnings growth, certeris paribus on multiples. No capital gains taxes are due until sale, so one's investment compounds up at a superior rate ... especially if one has a dividend reinvestment plan in place for any dividends they may pay out along the way as well.

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I have never seen a study, nor have I thought about the easy issuance as an influence on the cost of capital. But my guess is the effect is small, but real. But I think it is likely so small as to not unduly influence stock market returns. But I am guessing here.

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It would go out at a predictable price, without the fees to a brokerage consortium issuer, so much more cost effective to the company,

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The recent introduction of the NIXT ETF makes me wonder who buys a company‘s shares when it‘s removed from the index? You suddenly have a lot of price-insensitive sellers, so you would hope that companies themselves, in addition to hedge funds (and RAFI‘s new ETF) would buy.

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In general when a company gets removed from an index - FTSE 100 say - it moves into the lower-capitalisation index - here, the FTSE 250. So FTSE 250 trackers buy. What's interesting is that the company goes from being a very small percentage of the FTSE 100 - usually around 0.05% - to being one of the largest companies in the FTSE 250, at around 1%. So although the overall effect is probably negative, it's nowhere near as bad as might be thought.

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The overall effect is negative, just like the overall effect of a promotion into a higher index is positive. This is simple the case because there are far more index trackers for the FTSWE 100 than the FTSE 250 and passive investors make up a larger share of the total shareholding in the FTSE 100 than the FTSE 250.

However, there was recently an interesting piece of research that showed that companies that have been dropped from the S&P 500 significantly outperform the S&P 500- afterward. This is simply a mean reversion in returns. Stocks with strong returns get promoted into an index while stocks with low returns drop out. Once that pattern reverts, the dropped stocks start outperforming again.

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here‘s a link to RAFI: https://www.rafi.com/index-strategies/ra-deletions-index-series

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Yes, a stock dropped outperforms after being dropped (don't know why), while the stock newly added underperforms (because it has been groomed for addition). This is an arbitrage opportunity: buy the dropped, short the added.

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"And because with a higher number of shares in circulation, the weight of a company in an index increases as well."

I'm not sure that's right. Indexes (excepting the DJIA, FT30 and a couple of others) weight companies according to their free float-adjusted market capitalisation. So yes, more shares might be thought to mean a larger market cap and a larger weight in the index, but surely the market pushes the price down in proportion to the new shares. That's obviously what happens when a company undertakes a split.

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That is true. I effed that up. Higher number of shares tends to lead to lower share prices like in a stock split. If you issue shares by stealth the market might not catch up with you in the short term but after a while the price settles down again.

Sorry that was my mistake.

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think rather the purple was mixed up ;-)

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Index trackers buy securities from various sellers, including:

1. _Authorized Participants_ (APs): Institutional investors, like banks and broker-dealers, that create and redeem ETF shares directly with the fund.

2. _Market Makers_: Firms that quote both buy and sell prices for securities, providing liquidity to the market.

3. _Broker-Dealers_: Intermediaries that buy and sell securities from their inventory or facilitate trades between buyers and sellers.

4. _Institutional Investors_: Pension funds, mutual funds, hedge funds, and insurance companies that trade securities in large quantities.

5. _Individual Investors_: Retail investors who sell securities through their brokerage accounts.

6. _Other Index Funds or ETFs_: Funds that rebalance their portfolios or merge with other funds, selling securities to index trackers.

7. _Companies themselves_: During stock buybacks or when issuing new shares.

These sellers provide the liquidity that index trackers need to maintain their portfolios and track their underlying indexes.

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I wonder how much of the new issuance isn't an announced public sale, but is stock based compensation, which filters through employees before hitting the public markets. This is reported in 10Ks but I've never seen it compared to index members.

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Quite a lot of the new issuance is issuance to cover options. I don’t know the percentages but in the UK block issues in the primary market are common but far less than total issuance.

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Confess to a slight uneasy feeling here. Index fund gives £1m to large corporation (market cap say £10bn). Corporation creates £1m worth of new shares (0.01% of market cap) and gives them to index fund.

Existing shareholders might just have had their pockets picked... depending whether the company spends the £1m on something useful or on giving the top management team two weeks all expenses paid skiing holiday in a five star hotel in a fancy resort...

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