Key points

• Passive investing plays an important role in the Australian share market with >30% of the market held by passive investors.
• ‘Creative destruction’ results in new, innovative companies added to the benchmark, replacing companies in decline.
• Index rebalances are an important feature of the Australian equity market, resulting in large trading volumes and potential short term price distortions for the companies most impacted.
• Companies that are added to the S&P/ASX 300 benchmark receive increased market scrutiny, greater research coverage, and are generally held to higher governance standards (board composition, remuneration practices etc) than Ex-300 companies.

The past 30 years has seen a seismic shift from active to passive investing, creating considerable debate over the value each method provides to investors. Arguments aside, the rebalancing required to maintain passive investment strategies can create pricing opportunities for investors.

Passive investing involves investing in a portfolio of stocks weighted by value in a market index, such as the S&P/ASX 200, which captures by market capitalisation of the top 200 listed Australian stocks, or S&P 500 which follows the top 500 US stocks.

As market capitalisations change, companies move in and out of the index, requiring a passive portfolio to rebalance its weighting to maintain its tracking of the index. It is this rebalancing that can create opportunities.

These passive portfolios include mutual funds and ETFs as well as large institutional funds and superannuation funds, which is why rebalancing can have a significant impact as the funds in play are huge.

Active investing, by contrast, does not have a rebalancing effect as it involves a manager selecting stocks based on what the manager thinks the company is worth and if it is undervalued. Portfolio selections can vary significantly and operate on different time horizons. Active funds are typically more expensive in terms of fees and costs, as the manager is trying to achieve better returns than the market.

Identifying the window of opportunity

In Australia, a key benchmark is the S&P/ASX 300, which is the benchmark used by APRA to compare fund performance across superannuation funds.

Every six months, in March and September, the ratings agency and creator of many major market indices, S&P Global Ratings, announces changes to the S&P/ASX 300.  Other benchmarks in its suite, including the S&P/ASX 200, are rebalanced quarterly.  These changes come in three main forms:

• Additions and Deletions
• Changes to the weighting factor (reflecting any significant long-term owners of the stock)
• Changes to the number of shares on issue (reflecting shares issued in capital raisings and/or bought back by the company)

As a result of these changes, the ‘weight’ of each stock in the benchmark will change, resulting in buying and selling by passive investors to reset portfolio weights to mirror the new benchmark weights.  There is typically a one-to-two-week window between the initial announcement and the implementation date, allowing market participants time to prepare for the resulting trading activity.

Of the three changes, the first is generally the most significant.  Every six months a new set of companies is added to the S&P/ASX 300, replacing names that are removed from the benchmark.  These changes are driven by changes in share price and market capitalisation – companies with higher market capitalisation replace those with falling market capitalisation.  This is an example of the economic concept of ‘creative destruction’:  New, innovative companies replacing older, underperforming companies.

Tracking new arrivals and departures

In early March, S&P announced the changes for the March rebalance with implementation on 24 March.  Examples of stocks that were added include Catapult Group (CAT), a sports technology company developing performance-tracking devices used by leading global sporting organisations, DigiCo (DGT), a developer of data centres for cloud-based computing and AI, Generation Development (GDG), a financial services company led by ex-Olympian Grant Hackett, and Botanix (BOT), a biotech developing treatments, including one to manage excessive underarm sweating. Supply Network (SNL), a provider of parts for trucks and SRG Global (SRG), an engineering services company were also added.

On the resources front, gold companies slipped into the list thanks to a strong gold price. They include:  Catalyst Metals (CYL), Ora Banda Mining (ORA) and Pantoro (PNR).

Finally, stocks like Myer (MYR) and Equity Trustees (EQT) are making a re-entry to the benchmark.  The companies being removed include a mix of rare earths, lithium, and EV-battery names, reflecting the impact that oversupply and falling demand for electric vehicles is having on raw commodity prices and resources companies.

Rebalancing by passive investors can involve significant trading and short-term price distortions, particularly on the day of the implementation.   Investors targeting rebalancing periods try and predict the ‘adds and deletes’ and pre-position their portfolios.

Typically, in the period prior to the rebalance, stocks that are being added will outperform the benchmark, while stocks being deleted will underperform.  Once included in a key benchmark, stocks will benefit from ongoing demand from passive investors as money flows into this segment of the market.  Every dollar that is invested in a passive strategy theoretically results in buying across all 300 stocks, supporting share prices.

Promotion to the S&P/ASX 300 is often viewed as a source of pride for the added company – a sign that the company has ‘made it’.   Executive and Board remuneration often increases, and it can make the company a more attractive option for potential employees and suppliers.  However, on the flipside, there is greater market scrutiny and higher governance expectations.

Conclusion

Understanding the mechanics of index rebalances can help investors make more informed choices.  For those with a longer-term focus, temporary price distortions following rebalancing implementation may present buying opportunities in stocks that have been de-weighted.  Conversely, investors may wish to exercise caution when considering stocks newly added to the benchmark, as prices may reflect short-term buying pressure from passive investors.

Index rebalances highlight the mechanical nature of passive investing, where weight changes drive buying and selling regardless of company fundamentals. At NAB Private Wealth, investors have access to a number of tools to help take advantage of potential changes in the index.

To discover more call 1300 683106 or email us on investordesk@nab.com.au

The information contained in this article is believed to be reliable as at April 2025 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article. ©2025 NAB Private Wealth is a division of National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686.