Investing in Stocks Not In Index Funds

Introduction: The Intermittent Accuracy of Intuition!
The Magnitude of this Mispricing
Characteristics Today
Conclusions
Exhibits
Appendix: What May be the Truly Forgotten

Introduction: The Intermittent Accuracy of Intuition

Kailash Capital Research, LLC has often noted that human intuition can be the enemy of successful outcomes. We are all prone to a bevy of behavioral biases that drive us to do what we should not. There are however times when our intuition proves adept at helping us see potential opportunities. Over the last several months Kailash Capital Research, LLC has heard a rising chorus to look at the smaller stocks that are not included in the indexes. The thought being that with the rush to passives the stocks outside of the index might present a unique opportunity and inefficient pricing. In the following paper we attempt to assess and identify the opportunity.

Get our White Papers direct to your inbox: SUBSCRIBE

For the sake of our analysis we looked at all the firms that passed our data integrity checks for the Small & Mid Cap universe but were also not in the Russell 2500 (that universe’s benchmark). These firms we deemed “The Forgotten.” Companies that were excluded from the Russell 2500 but also met our Tier 1 data checks with an emphasis on those that also passed our Tier 2 data integrity checks. As a reminder:

1. Tier 1 Data Checks: Include a large host of data requirements we consider “basic” to universe inclusion. As a means of basic example these Tier One Checks include simple items like ensuring quarterly data filings are up-to-date, there has been no change in primary issuers and excluding firms that have primary listings overseas. This is obviously a very small sample of our requirements but is hopefully illustrative of what it takes to be included in one of our Universes
2. Tier 2 Data Checks: These are the far more strenuous and proprietary data requirements we impose on companies if they are to qualify for actually receiving a ranking in one of our models.

In our Small & Mid Cap Universe there are currently 76 Forgotten firms with 60 of those forgotten firms meeting the data requirements necessary to pass our Tier 2 Data Checks and receive an aggregate rank.

Figure 1 below focuses on the latter group, those with aggregate ranks, to bring context to the idea that out-of-index firms might indeed offer unusual value in this age of brain-dead indexing. As money blindly pours into indexes the intuitive idea that forgotten firms might offer uncommonly fertile ground for researchers to work in appears to be absolutely correct! Rarely in their history have non-index stocks ranked as highly as they do today.

Subscribe now to unlock the full content

Already a member? Click here to log in

SERVICES

As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade. If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you. KCR also offers a wide range of easy-to-use but sophisticated tools. Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
Kailash Capital Research, LLC ’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias. L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital Research, LLC and its affiliates (collectively, “Kailash Capital Research, LLC ”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital Research, LLC . In preparing the information, data, analyses, and opinions presented herein, Kailash Capital Research, LLC has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital Research, LLC , however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital Research, LLC and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital Research, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital Research, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital Research, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital Research, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital Research, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.