Another Bull Market Ignored! Legendary investor recommends buying in "unnoticed areas"
According to Research Affiliates' research, excluded stocks provide investors with unexpected excess returns. Founder Rob Arnott pointed out that these stocks performed extremely well in the five years after being excluded, with an annual return 5% higher than the market. The research also indicates that the selling pressure experienced after excluding stocks often leads to lower prices than before exclusion, with significant potential for rebound. Research Affiliates will launch the NIXT index, focusing on these excluded stocks, and is expected to outperform the market in the next decade
According to a new study by Research Affiliates, stocks that are excluded from major indices may bring unexpectedly high returns to investors willing to bet on them.
The company's founder, investment legend Rob Arnott, and vice president Forrest Henslee wrote that stocks excluded from indices have shown remarkable sustained outperformance of the market for at least five years. After being excluded from the index, these stocks can generate an average annual return that is 5% higher than the market.
The authors wrote: "Ignoring trading costs, an investor holding a portfolio of widely excluded stocks will be 74 times wealthier by the end of 2023 than in January 1991. Investors holding the Nasdaq 100 index have performed equally well, despite higher volatility and experiencing significant declines during the bursting of the dot-com bubble."
To test this theory over the next few decades, Research Affiliates announced the launch of the NIXT index. This fund will buy excluded stocks and hold them for five years.
So, what makes these unpopular stocks so special that they can consistently generate excess returns?
Arnott wrote that when stocks are excluded from an index, they actually face excessive selling pressure.
The report states: "Excluded stocks experience significant selling pressure because index fund investors must sell their holdings; therefore, the market price of excluded stocks is usually much lower than before the exclusion decision, laying the foundation for a strong rebound later."
At the same time, the research report found that the companies replacing the excluded companies in the index do not have much to boast about.
The research shows that companies replacing excluded companies often underperform in the following year, generally lagging slightly behind the average performance. For example, from 1990 to 2020, the new constituents added to the S&P 500 index lagged the market by 1%-2%.
Arnott stated that now is also a good time to consider building an exclusion portfolio, as these stocks may further outperform the market in the next decade. He added that this is because the current growth-driven bull market will eventually fade, giving small-cap and value stocks greater upside potential