MARKETS SPECTATOR: New stocks on the block

Morgan Stanley says even smaller stocks newly included on a large market index often outperform, while the main barrier to inclusion is limited liquidity.

The inclusion of a stock into a large market value index does not mean it will underperform others in the index, even if its market capitalisation is dwarfed by the biggest companies in the index, Morgan Stanley says

The broker’s analysts say their studies of stocks after a one-month post inclusion in the S&P/ASX 100 Index, show that 70 per cent of the stocks had a 2.5 per cent median outperformance. Over three months, 68 per cent were outperformers with a relative outperformance of 5.2 per cent. One third delivered an outperformance in excess of 10 per cent. Over 12 months, 62 per cent were outperformers with a relative outperformance of 7.5 per cent. The top 15 stocks delivered outperformance in excess of 25 per cent over the year, Morgan Stanley says.

“Stocks with severely limited liquidity will be penalised in terms of index inclusion regardless of market cap,” says Morgan Stanley.

“In recent times we have detected a discernible trend for liquidity to be less of an issue than often is expected.”

Standard & Poor’s, says the broker, is taking into account company business models to try and ensure it has the highest quality companies in its indexes. Index volatility, as a result, may decline, the broker says.