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Advisors and equity and indexing nerds may be aware of the phenomenon of some – emphasis on “some” – stocks being removed from major indexes and then going onto deliver impressive performances.
Barron’s examined the trend pertaining to departures from the Dow Jones Industrial Average. In the publication’s June 2018 article on the topic, it was noted that dating back to 1999, stocks expelled from the Dow went often outpaced the names added to the benchmark.
Buying stocks on the basis of removal from a major index isn’t a foolproof strategy, but there are some notable examples of it working out, depending on the time frame. Oil giant Exxon Mobil (NYSE: XOM) was removed from the Dow in 2020. Since the start of 2021, the shares have more than tripled. eBay (NASDAQ: EBAY) was ejected from the Nasdaq 100 Index in December 2023 as part of that gauge’s annual rebalance. Shares of the online auction site are up 70% over the past year.
Of course, stock-picking among index deletions is a burdensome task. Fortunately, there’s an ETF for that – the Research Affiliates Deletions ETF (NASDAQ: NIXT).
Examining NIXT
NIXT debuted last September so it’s not yet old enough for investors to get caught up on performance. The ETF follows the Research Affiliates Deletions Index, which is taps into the notion that stocks that expelled from major indexes are “unloved” though often go on to deliver market-beating returns.
“Market capitalization-weighted indices all follow a common pattern. Stocks are added when they are valuable and beloved enough to get on the radar of the investment community. The stocks that are conversely deleted from these indices are almost always unloved, have fallen out of favor, and are no longer valuable enough to be deemed important,” according to Research Affiliates.
A simple way of looking at NIXT is that the ETF does the opposite of what standard, pure beta cap-weighted ETFs and index funds. That being adding stocks that have already been bid higher and now meet the index’s market capitalization requirements for inclusion. While waiting stocks by market value plays on the collective of wisdom of market participants, it can also mean some overvalued stocks find their way into important indexes.
NIXT is the antithesis of that approach. If anything, the ETF rejects dependence on large-cap growth and shapes up as more of a small-cap value play.
“Recent index deletions are typically small cap value stocks. This approach provides a thoughtful way to gain small cap value exposure by adding recent index deletions that historically have had attractive valuations relative to the market,” adds Research Affiliates.
More NIXT Tidbits
Candidates for inclusion in NIXT’s underlying index hail from two internal indexes managed by Research Affiliates, which are comparable to the S&P 500 and the Russell 1000.
Perhaps adding to the allure of NIXT is the implementation of a quality screen. The index providers screens its two internal gauges on the basis of debt coverage and issuance ratios, leverage changes, equity issuance and net and total payouts. Stocks scoring in the bottom 20% cannot be included in the NIXT index. Said another way, NIXT components may be unloved, but they’re not necessarily financially flimsy.
As for sector exposures, it’s likely NIXT will be sector agnostic over time because there’s simply no telling which industries will be homes to more index deletions than others. For now, the ETF allocates nearly half its weight to the consumer cyclical, healthcare and technology sectors. Real estate and financial stocks combine for another 21.7%.