This module is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 9 of 10 · 13 min
Rebalancing, reconstitution and what indexes are used for
Rebalancing resets weights to the index's rule and reconstitution changes which securities are in it; both create turnover, and the finished index then serves as a sentiment gauge, a market proxy, an asset-class proxy, a benchmark and a model portfolio.
In short
- Rebalancing = adjusting constituent weights back to the weighting method on scheduled dates, usually quarterly. It is needed because prices move weights.
- Equal-weighted indexes need the most rebalancing; price-weighted indexes are never rebalanced; cap-weighted indexes largely rebalance themselves (adjusted only for corporate actions).
- Reconstitution = changing the constituents: re-apply the inclusion criteria, retain, remove or add securities, then re-apply the weighting. It keeps the index representative of the target market.
- Both create turnover; anticipated reconstitution can push up prices of likely additions and push down likely deletions.
- Uses: market sentiment gauge; proxy for returns, systematic risk and risk-adjusted performance; proxy for asset classes in asset allocation; benchmark for active managers; model portfolio for index funds and ETFs.
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