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9/4/2018 When A Stock is Added or Removed From the Nifty 50, What Happens Next?

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General
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» When A Stock is Added or...

When A Stock is Added or


Removed From the Nifty
50, What Happens Next?

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9/4/2018 When A Stock is Added or Removed From the Nifty 50, What Happens Next? - Capitalmind

Prashanth Krish
(https://capitalmind.in/author/prashanth1/)
12 April, 2017
GENERAL

(https://capitalmind.in/category/general/)

Tags

NIFTY 50
(HTTPS://CAPITALMIND.IN/TAG/NIFTY-

50/)

The National Stock Exchange has about 58 Equity related


Indices one can track even though most investors / traders
follow a very small sub-section of it. Nifty 50 is one of the
more widely tracked Indexes in India with the 51 stocks (don’t
ask!) of the Index.

While the Index remains a constant, the stocks that are part of
the Index see changes over time. Since 1996, the Nifty 50 has
seen addition of 86 stocks and removal of 85 stocks. Since
April 2016, Nifty 50 has consisted of 51 stocks – this is due to
the addition of Tata Motors Ltd DVR. (Tata Motors itself is part
of the index, so there are just 50 companies in the index; the
only di erence is in the voting rights of the holders of DVR
shares versus the Ordinary shareholders)

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The frequent churn that one has seen in the Indices has also
meant that for a few stocks, it has been a merry-go-round
with them seeing inclusion / exclusion multiple times. A case
in point would be Dr.Reddy’s Laboratories. DRREDDY (ticker
symbol on the NSE) was part of the Original 50 stocks but got
dropped in 1997. In 1999, the stock was once again included
back in the Index but was dropped for the second time in
2008. It saw inclusion for the third time in 2010 and stays as
part of the Index since then.

Inclusion of stocks in any index that is tracked by a large


number of funds can easily bump up returns of the stock. For
instance, just the rumor of inclusion of REC into the MSCI
Index drove the stock up 13% earlier today.

Inclusion of stock in an Index can convey positive information


about the longevity and prospects of that rm, because of the
certi cation hypothesis (Dhillon and Johnson
(https://editorialexpress.com/cgi-
bin/conference/download.cgi?
db_name=foro nanzas2008&paper_id=17) (1991); and Jain
(1987)).

Why are stock removed?


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9/4/2018 When A Stock is Added or Removed From the Nifty 50, What Happens Next? - Capitalmind

Stock Exclusion from an Index happens due to one of the two


key reasons. One would be a period of underperformance
which would have dragged down its market capitalization and
provide a space for entry of alternatives.

A secondary reason would be based on corporate action of


the company such as merger with another company,
demerger or delisting.

In 2015, IDFC was removed from the Nifty 50 Index since it


was going to demerge from its banking arm. In its place,
Bosch found a place in the Index for the rst time. The change
also meant a reduction in total weight of nancial companies
while automotive ancillary company weights (as a whole) went
up.

Do Inclusions or Exclusions Have Investible


Value?
Our question is, once a stock is removed or added to the
Index, how the stock behaved over the coming one, three and
ve years.

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For our analysis, we have taken data from 2005 to 2017


during which period we saw 45 stocks being added while 44
were removed.

Out of the 44 exclusions, 3 were for reasons of a forthcoming


merger while 2 were due to forthcoming de-mergers.

In India, most mergers and demergers have been positive, so


let’s ignore that. What about the rest, how did they perform
over the coming year, 3 years and 5 Years?

Stocks That Were Removed: The median return of the 37


stocks that were removed and were measured after 1 year,
has been 11.33% .

Over 3 years, we have a total of 30 stocks (which stayed out)


which delivered median absolute gains of 9.69%. This is small:
9.69% in three years is about 3% a year.

Going further, 22 stocks which were removed and stayed out


of the Index for 5 years, median absolute return comes to
45.32%. Again, unimpressive as it’s less than 9% per year.

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But are these returns good or bad? The answer to that


question lies in the returns generated by stocks that have
replaced the above stocks in the Index. Over the same
periods of time, 1, 3 and 5 years, median absolute gains
by stocks that were included in the Index have been
107.87%, 105.19% and 89.26% respectively.

Meaning: If a stock was included in the index, they’re quite


likely to gain big time. Most of the gains seem to come in the
rst year (median: 108%). Even in a ve year time frame,
absolute returns are about 90% (which is about 14% a year).

(https://capitalmind.in/wp-
content/uploads/2017/04/Nifty-1.png)
Stock Returns post Action

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9/4/2018 When A Stock is Added or Removed From the Nifty 50, What Happens Next? - Capitalmind

So it makes immense sense to chuck out a stock out of one’s


portfolio as soon as it leaves.

And then, to buy a stock immediately when it’s been added to


the Nifty, for a 1 year hold.

Why do stocks move up like this?


When a stock is added to the index, there are exchange
traded funds that will buy in, so that they can track the index.
Other market participants who benchmark themselves with
the index (such as mutual funds) will also buy so they don’t
miss out if that one stock breaks out.

There’s other reasons too, such as increased liquidity for such


stocks, and the fact that they are now in the index because
their market cap is moving up.

All market-cap weighted Indexes like the Nifty 50 are closet


momentum portfolios. They try to keep up with the trend by
adding winners (who have moved up in market cap) and

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9/4/2018 When A Stock is Added or Removed From the Nifty 50, What Happens Next? - Capitalmind

eliminating losers. In other words, they follow the maxim: Let


your winners ride and cut your losers short. It seems it’s best
to just follow what they do.

Now, tell them about it:

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