The original article was published in the Financial Analysts Journal.
How many excluded stocks does it actually take to make a significant impact on a portfolio? In this paper, we used simulated historical backtests to study the impact of stock exclusions on the performance of passive and active portfolios.
The rise of “personalized indexing” has allowed investors to customize their stock selections and enable tax loss harvesting, improving the portfolio’s return or risk characteristics, socially responsible investing, and single-stock exclusions. Each of these personalizations lead to excluded stocks. We explored what impact such restrictions could have on a portfolio’s expected performance.
Our paper found that at low to moderate numbers, stock exclusions have very little influence on passive portfolios. Overall, our results suggest that investors should feel comfortable excluding a fairly large amount of stocks before experiencing any significant deterioration in their investment performance.
– Yin Chen and Roni Israelov