Joining the S&P 500 index has been treated as a stamp of approval, signaling that a company has truly arrived. A recent study has challenged the conventional wisdom and found that over the long term, S&P 500 additions don’t just fail to outperform—they significantly underperform comparable companies that never made it into the index (all returns in this article are measured on a US dollar basis).
For investors who passively hold index funds or systematic quant strategies, or for those constructing active equity portfolios, this finding has meaningful implications. Here’s what Neill Sandifer, Joey Smith, and Johannes Impink, authors of the study “S&P 500 vs. Peer Firm Performance: Does Index Inclusion Matter?,” found, how they found it, and what it means for your investment thinking.
A Better Way to Ask the S&P 500 Question
Most prior research on inclusion in the S&P 500 focused on short-term price movements—what happens to a stock in the days or weeks after the announcement. And the short-term story is well-established: When a company joins the index, its stock typically jumps as passive funds rush to buy it to match the benchmark. That temporary bump has been documented across decades of studies. The simple explanation is that predicting S&P additions has been a big business, with the additions already anticipated by sophisticated investors. It’s also worth noting that the price rises on announcement day but then can fall on the actual addition date. In both cases, the folks in the early stages are selling to the indexers at potentially inflated prices.
But Sandifer, Smith, and Impink asked a different and more important question: What happens over the long run, and compared with what? They used a three-year event window after each index addition and benchmarked performance not against the index itself or the broad market, but against carefully matched peer companies that were never added to the S&P 500.
Their matching algorithm paired each S&P 500 addition with a nonconstituent company from the same industry (using Fama-French 48 industry classifications), with similar market capitalization, and similar profitability as measured by return on assets. This created 331 matched pairs spanning 35 years of data (1989–2019), drawn from CRSP and Compustat databases.
By comparing S&P 500 additions to their closest nonconstituent twins, the researchers could isolate the effect of index inclusion itself—stripping away industry trends, size effects, and baseline profitability differences. Below are their key findings.
1. Added Stocks Underperform by a Wide Margin
Controlling for firm size, book/market ratio, profitability, trading volume, leverage, and industry and year fixed effects, companies added to the S&P 500 generated significantly lower cumulative abnormal returns than their matched peers who stayed out of the index.
The underperformance compounded over time:
- Over one year: Added firms underperformed matched peers by 28%.
- Over two years: The gap widened to 33.1%.
- Over three years: Underperformance reached 40.2%.
- Over five years: The deficit grew to 55.2%.
The authors note the effect holds even at 10 years.
These results are highly statistically significant (at the 1% level in the base case, t-value = negative 6.37) and held across numerous robustness checks—different time buffers, different industry classification systems, different levels of data winsorization, and the Carhart four-factor model. Thus, the finding is not a fluke of a particular specification.
The researchers also conducted a sensitivity test, comparing added firms not to matched peers but to themselves in other periods. The results showed that in the three years before joining the index, these same companies generated a large positive abnormal return of around 77%. The fact that they rose should not be a surprise because the increase in valuation is what led them to be considered for inclusion. After joining? The pattern reversed sharply. The index addition date appears to mark a turning point.
2. S&P 500 index Members Are More Volatile
The underperformance is not just a return story; it came with more risk, too. The authors found that companies added to the S&P 500 experienced statistically (t-value = 2.84) higher stock price volatility than their matched nonconstituent peers over the same three-year period.
This finding aligns with prior academic work suggesting that index inclusion pulls a stock’s price behavior toward other index members—a concept called “comovement”—potentially introducing volatility that is not driven by the underlying business fundamentals of the individual firm.
3. Fundamentals Deteriorate, Too
Perhaps the most significant aspect of this study is that it goes beyond stock prices to examine business performance. Across four measures of fundamental profitability (return on assets, return on equity, return on invested capital, and net profit margin), S&P 500 additions underperformed (statistically significant at the 5% level) their matched peers over the three years after inclusion.
Why Does This Happen? The Hidden Costs of Prestige
The authors offer a theoretical framework to explain their findings. While the benefits of S&P 500 inclusion—greater investor awareness, improved liquidity, institutional ownership, and certification effects—are well-documented in prior literature, the costs have been largely overlooked. The researchers identify five distinct cost mechanisms:
1. The Hunger Factor Hypothesis
Like a newly crowned champion who loses the drive that made them great, companies that gain index membership may lose the competitive urgency they had before “arriving.” Executive teams that worked tirelessly to reach the S&P 500 may shift into a more comfortable, less aggressive operating mode.
2. The Peer Pressure Hypothesis
Once inside the index, companies face pressure to benchmark executive compensation against other S&P 500 firms—typically much larger companies. This ratchets up pay levels and adjusts the structure of compensation (more stock options, higher base pay) in ways that may not be value-additive for shareholders.
3. The Eustress Hypothesis
Before joining the index, companies must actively court and perform for a demanding base of active investors scrutinizing their every move. After joining, a large portion of their shareholders become passive index funds that will hold the stock regardless of performance. The positive pressure (“eustress”) of active investor oversight diminishes.
4. The Pay-to-Play Hypothesis
S&P 500 membership may bring elevated regulatory, audit, and compliance burdens. It may also generate sociocultural pressure to adopt expensive environmental and social initiatives or governance structures that, while perhaps socially desirable, do not necessarily create economic value.
5. The Window Dressing Hypothesis
In the period leading up to inclusion, companies may engage in short-term financial management to look more attractive to the S&P committee—cutting R&D, managing earnings, or adjusting leverage in ways that flatter near-term metrics but ultimately weaken the business. Note that the authors did not test for this.
Another explanation is that part of the story could be from the long-term reversal effect first studied by Werner De Bondt and Richard Thaler in their 1985 paper “Does the Stock Market Overreact?” However, the finding of the effect is seemingly much stronger in this new paper.
And this isn’t just a recent phenomenon. Some prior studies have suggested that index-inclusion effects changed around 2008, with more negative outcomes appearing only in the “late period.” Sandifer, Smith, and Impink tested this directly by splitting their sample into pre- and post-2008 periods. They found that while the post-2008 period as a whole showed lower stock returns, the added-firm underperformance was not meaningfully different across the two periods. The effect of index inclusion on relative long-run performance appears consistent across their full 35-year sample.
What This Means for Investors
This research is not a reason to panic about index funds, but it does invite some careful reflection. Here are the key takeaways worth considering:
1. Treat Index Inclusion as a Potential Sell Signal, Not a Buy Signal
Active investors who see S&P 500 inclusion as confirmation of quality may be making an error. The research suggests that inclusion tends to coincide with a performance peak—companies are often at their best just before they join, having run hard to reach that milestone. The three years after joining may be a period of relative disappointment.
2. Don’t Overlook the Near-Miss Companies
The nonconstituent matched firms in this study—companies that were similar in size, industry, and profitability to S&P 500 additions but never made the cut—outperformed significantly. These are companies that still have something to prove. For active managers willing to do the research, the pool of large, profitable companies just outside the S&P 500 may be a fertile hunting ground.
3. A Long-Short Strategy May Generate Alpha
The authors themselves suggest a practical trading application: a long-short portfolio that goes long matched nonconstituent peers and short recent S&P 500 additions. Given the magnitude of the performance spread (28% to 55% over one to five years) and the higher volatility of the index additions, the risk/return profile of such a strategy could be attractive. Institutional fund managers with the flexibility to short individual stocks may find this a compelling idea worth exploring further.
4. Passive Investors Should Understand What They Own
This research does not mean passive index investing is a bad strategy. The S&P 500 has generated strong long-run returns, and the cost advantages of passive funds remain compelling. But it does highlight that index reconstitution creates a systematic dynamic: The index tends to buy stocks near their relative peak, and the funds that track it cannot do otherwise. Investors should be aware that the very mechanism of index rebalancing creates a headwind that can be exploited.
5. Watch the Fundamentals of Recent Additions
Because the underperformance of S&P 500 additions appears to be rooted in deteriorating operating fundamentals—not just a mean-reverting stock price—active investors should closely monitor the profit margins, return on assets, and return on equity of recently added companies. Margin compression in the quarters following index inclusion may be an early warning sign worth heeding.
Important S&P 500 Inclusion Caveats
The authors are careful to note that their study establishes correlation and temporal precedence, not causation. We cannot say definitively that index inclusion causes underperformance; it may be that the type of company that gets added to the index at that moment in its lifecycle tends to underperform regardless. However, the study’s design—particularly the careful matched-pair methodology and sensitivity tests—does much to address these concerns.
Additionally, the study’s long data requirements (at least seven years of data per firm) necessarily exclude the most recent additions and mean the results reflect a sample weighted toward older observations. Whether the findings apply with equal force to very recent additions remains to be seen. It is also worth noting that the dataset ends in 2019, predating both the covid-era market dislocations and the continued surge in passive investing’s market share. Given that the study itself acknowledges post-2008 conditions as potentially relevant, readers should consider whether the structural changes of the past several years may affect how the effect manifests in the future.
Most importantly, the finding of a 28% underperformance in the first year after inclusion seems implausibly high. I raised this directly with the authors, who confirmed they rechecked their data and stand behind the result. That said, two additional robustness tests would further strengthen confidence in the findings. First, the authors could drill deeper into the size effect by using Ken French’s database and controlling for size using deciles 9–10 versus decile 1 instead of SMB (which uses deciles 1–5 versus 6–10)—an approach that would more closely mirror their own matching process. Second, a straightforward test would be to compare the additions against firms already in the S&P 500 at the time of inclusion. Existing members would provide better size-matched comparisons, and because the central thesis is that additions underperform postinclusion, one would expect them to lag their already-included peers as well.
The Bottom Line for Investors
The S&P 500 is not a bad investment. But this research suggests that the moment of index addition—that celebrated arrival into America’s most exclusive corporate club—may be precisely the wrong time to increase exposure to a stock. The companies that just missed the cut, the “almost constituents” that are still hungry, still courting active investors, and still operating without the soft cushion of guaranteed passive fund demand, may be where the better long-run returns are hiding.
