Tipping Point: Why is a stock discarded from an index?

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Most indices in India are weighted by market capitalisation. If the market cap of a stock falls and that of another rises, the former is discarded and the latter is included in the index.  

Why does a portfolio comprising index discards outperform the index? 

Studies have found that a portfolio of index discards beats the index. When it is announced that a stock will join an index, it attracts investors' attention and they buy it.

Many institutions have exchange-traded and index funds. They invest in the stock when it is included in the index, driving its price up. By the time the stock enters the index, it has already become expensive.

The outgoing stock gets adverse attention and is discarded by many retail and institutional investors, driving its price lower. An investor who builds a portfolio of discarded stocks buys them at lower prices.


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