What happened

Bermuda-based reinsurer Third Point Reinsurance (NYSE:TPRE) will be added to the S&P SmallCap 600 index on September 26, 2017, replacing food producer Sanderson Farms. Sanderson Farms is going to be added to the S&P MidCap 400 index, where it will be replacing Cabela's after the acquisition of the latter by Bass Pro Shops is completed.

As a result of the announcement, Third Point Reinsurance popped as much as 12%, and it's up more than 9% as of this writing, at 11 a.m. on the day the index-shuffling moves were announced.

Businessman pointing toward "insurance" on a screen.

Image source: Getty Images.

Now what

As the name implies, the S&P SmallCap 600 index is designed to track the small-cap segment of the U.S. stock market. The index is a collection of 600 stocks with an average market capitalization of $1.26 billion, and criteria for inclusion include (but are not limited to):

  • Market cap between $450 million and $2.1 billion.
  • At least 50% of shares outstanding available for trading.
  • Positive earnings in most recent quarter as well as most recent four quarters added together.
  • Adequate liquidity.
  • Must maintain the index's sector balance -- for example, the number of reinsurance stocks in the index must be in line with the proportion of reinsurance stocks in the actual universe of eligible companies.

The index represents the smallest companies in the S&P Composite 1500 index, which also includes the S&P MidCap 400 and the well-known S&P 500 index of larger companies.

So what

There are a few reasons stocks tend to rise after being added to an index. The biggest reason is the anticipation of a surge in buying activity from passive index funds. In other words, index funds that track the S&P SmallCap 600 will now have to buy shares of Third Point Reinsurance in order to maintain a portfolio that's representative of the underlying index.

In addition, since the criteria for inclusion in the index have to do with the financial health of the company, being chosen for an index like the S&P SmallCap 600 could be seen as a sign that things are going better for the company than investors had expected.

Matthew Frankel has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.