Lesson 10 of 12 · All lessons in this module
  1. Money-weighted return
  2. Time-weighted vs money-weighted returnVideo lesson
  3. Which return to report: managers, investors and GIPS
  4. Integrated cases: balance tables, money-weighted and time-weighted returns
  5. What an index is: value, price return and total returnVideo lesson
  6. Index objectives, custom indexes and choosing a version
  7. Building an index: target market, constituents and weighting
  8. Price-weighted and equal-weighted indexesVideo lesson
  9. Market-cap, float-adjusted and fundamental weightingVideo lesson
  10. Rebalancing, reconstitution and what indexes are used for
  11. Rebalancing in shares, weight drift and reconstitution rules
  12. Integrated cases: one market, three weightings and a stock split

This lesson 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 10 of 12 · 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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