Benchmarking Intensity

Abstract

Benchmarking incentivizes fund managers to invest a fraction of their funds assets in their benchmark indexes, and such demand is inelastic. We construct a measure of inelastic demand a stock attracts, benchmarking intensity (BMI), computed as its cumulative weight in all benchmarks, weighted by assets following each benchmark. Exploiting the Russell 1000/2000 cutoff, we show that changes in stocks BMIs instrument for changes in ownership of benchmarked investors. The resultant demand elasticities are low. We document that both active and passive fund managers buy additions to their benchmarks and sell deletions. Finally, an increase in BMI lowers future stock returns. (JEL G11, G12, G23)

Which Investors Matter for Equity Valuations and Expected Returns?

“…Even hedge funds, which are the most elastic among institutional investors, have a wealth-weighted price elasticity of demand around 0.5. Thus, we agree with a recent literature, which builds on an earlier literature on index effects (Harris and Gurel, 1986;Shleifer, 1986), that finds price elasticities of demand that are much lower than those predicted by traditional asset pricing models (Chang et al, 2014;Koijen and Yogo, 2019;Pavlova and Sikorskaya, 2022).…”

On the Other Side of Hedge Fund Equity Trades

“…their benchmark index, purchasing stocks included in the index and selling stocks excluded from the index (Pavlova and Sikorskaya, 2022). It leads to comovement in the stock returns and an increase in the betas of these stocks with respect to their index (Barberis et al, 2005;Vijh, 1994).…”