Reconstitution

Changing which securities belong to an index, adding and removing members under its rules. The dates are known in advance, so others trade ahead of them and index funds pay for it.

Where you will meet it

Reconstitution appears in 5 learning outcomes on the CFA syllabus. A few of them:

• Set out the choices made when building an index
  CFA Level I · Equity Investments

  “An index provider must decide what the index is intended to measure, which determines the target market; how constituents are selected, whether by rule or by committee; how they are weighted; and how often the index is rebalanced and reconstituted.”

• Contrast the alternative ways of designing an index-based equity strategy
  CFA Level III · Portfolio Management Pathway

  “The investor picks the market segment (broad market, size band, style, region or sector) and then an index whose methodology fits: how constituents are selected, how often the index is reconstituted and rebalanced, and how it weights stocks.”

• Weigh the factors that matter when selecting a benchmark for an equity mandate
  CFA Level III · Portfolio Construction

  “Check reconstitution and rebalancing frequency, since frequent changes raise the cost of replication, and check concentration, because cap-weighted indexes can be dominated by a few names.”

• Explain how indexes are rebalanced and reconstituted
  CFA Level I · Equity Investments

  “Rebalancing resets constituent weights to the scheme the index specifies, and reconstitution changes which securities are members at all.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
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All terms beginning with R · Glossary