Aug

17

Wall Street’s Trash Contains Buried Treasure
Investors buying index-fund castoffs could have made 74 times their money since 1991

Rebound relationships are best avoided, but maybe not in the stock market.

In a paper that starts out by stating that “no one enjoys getting dumped,” two investing quants reveal some surprising, and potentially lucrative, traits of companies that have really let themselves go. With about half of the money invested in American stocks now sitting in index funds, and many active managers holding portfolios that resemble them — just try beating the market these days without “Magnificent 7” stocks such as Nvidia or Microsoft — index castoffs have a hard time meeting someone new.

That is when investors should pounce, says Rob Arnott, chairman of advisory firm Research Affiliates, with colleague Forrest Henslee. This week they are unveiling a stock index named NIXT that would have earned investors about 74 times their money since 1991 by buying stocks kicked out of indexes.

Big Al links:

The Disappearing Index Effect
Robin Greenwood & Marco Sammon, Harvard Business School
Revised, November 2023

The abnormal return associated with a stock being added to the S&P 500 has fallen from an average of 7.4% in the 1990s to 0.3% over the past decade. This has occurred despite a significant increase in the share of stock market assets linked to the index. A similar pattern has occurred for index deletions, with large negative abnormal returns during the 1990s, but only 0.1% between 2010 and 2020. We investigate the drivers of this surprising phenomenon and discuss implications for market efficiency. Finally, we document a similar decline in the index effect among other families of indices.


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