According to data compiled by ETIG database, 31 constituents of the Nifty 50 index have been replaced in the last 10 years. Comparing the performance of the 28 excluded stocks (three were delisted or merged) with their counterparts, 17 of the excluded stocks have outperformed stocks that were in the index, while two of the excluded stocks have performed at par with their counterparts.
For example, United Spirits was removed from the list in September 2014 and replaced by G Enterprises. Over the past decade, United Spirits’ share price has tripled, while G Enterprises’ share price has fallen by more than half.
UPL replaced Bank of Baroda in the Nifty 50 in September 2017. Since then, UPL’s share price has risen 6.4% while Bank of Baroda’s has risen 75%. Similarly, Indian Oil Corporation was replaced by Apollo Hospitals in March 2022. Since then, IOCL’s share price has doubled while Apollo Hospitals’ share price has risen only 45%.Why does this happen?
In many cases, stocks that are unpopular with investors and whose valuations have fallen tend to be removed from the index, while popular stocks whose valuations have risen tend to be included. However, in the long run, cheaper stocks tend to outperform more expensive ones. Globally, studies on index rebalancing effects have shown how stocks that are removed from a benchmark index tend to outperform stocks that are included. For example, in 2013, researchers Kalok Chan, Hung Wan Kot, and Gordon Tang investigated the long-term effects of additions and deletions to the S&P 500 index for a sample of stocks from 1962 to 2003 and found that both added and deleted stocks saw significant long-term price increases, with deleted stocks outperforming added stocks.
They attribute the long-term price increase of added stocks to increases in institutional holdings, liquidity, and analyst coverage, but find that the removal of stocks did not significantly affect analyst coverage, but institutional holdings and liquidity of removed stocks recovered.
We have found that stocks newly added to a benchmark index can experience a temporary price rise due to demand from index funds and institutional investors, but after the initial boost they tend to underperform the overall market. In contrast, stocks that are removed can quickly fall in price due to index fund selling.
A 2005 study by researchers Honghui Chen, Vijay Singhal, and Gregory Noronha showed that companies added to the S&P 500 see a permanent increase in stock prices, while companies removed see only a temporary decline. The researchers point to a change in investor perception to explain this price pattern: investor perception increases for stocks added to the S&P 500 index, but they don’t see a similar decline for stocks removed.
