It is December 1st, 2017. Tax loss harvesting season is almost upon us and has got me thinking a lot about forced selling and the types of situations that can force an investor to sell. The most obvious answer to that question is a stressed liquidity event (e.g, recessions), where an investor would be forced to sell his securities to fund current consumption. One problem: we’re not in a recession (at least according to government numbers).
So, I asked myself: Is there anything right now (aside from tax loss harvesting) that could potentially bring about a value opportunity? …One where an institution is forced to sell a security? Then it hit me. With the rise of passive investing, any constituent security that was booted from an index would force the ETFs that try to replicate that index to sell (assuming no tilt).
Due to the increased popularity of ETFs, when a constituent security is dropped from the S&P 500, forced selling from ETFs and index funds could potentially send the price per share of a company below its intrinsic value.
Over the next few weeks I will be examining this hypothesis by collecting data and back testing returns.
P.S. I’ve been told that this is a strategy that has been used by Baupost and I’m sure by numerous other asset managers (Who wouldn’t try to implement a strategy followed by Seth Klarman?). I intend to keep my thoughts original, and therefore am not looking into any of their thoughts on this strategy due to the fact that they may influence my analysis.