Which would you rather own: an up and coming company or a down and out former star on the decline, recently booted out of a major index.
According to a study authored by two finance professors, "The Long-Term Impact from Russell 2000 Rebalancing", the answer is, believe it or not, the latter. The study looked at how companies that have recently been added to the Russell 2000 fare compared with recent deletions. The New York Times sums up the results: "The researchers found that over this period, deleted stocks proceeded to perform markedly better than their replacements, on average. Over the 12 months after reconstitution, for example, the deleted stocks outperformed their replacements by an average of 9.3 percentage points. In the five years after reconstitution, the difference was 40.1 percentage points."
How can investors take advantage of that performance gap? It's tough because you cannot, by definition, use index funds. You have to think that an ETF will come along soon specializing in un-rebalanced index funds, but that hasn't happened yet. Wisdom Tree, get on it!
Index dropouts outperform the newcomers -- contrarian investing works!
Posted May 31st 2008 8:00PM by Zac Bissonnette
Filed under: Newspapers, Stocks to Buy
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Reader Comments (Page 1 of 1)
5-31-2008 @ 10:28PM
Lilguy said...
This phenomenon seems like an extreme version of the "dogs of the Dow" where the poorest performing Dow companies outperform the rest of the Dow the following year.
I guess getting kicked out of an index would mean an even better performance. Wonder how the Dow deletees do?