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Why these five stocks could outperform in March

The upcoming rebalance of the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) is likely to provide a tailwind for a number of stocks that are tipped to be included in the benchmark, according to Morgan Stanley.

The broker’s analysis shows that stocks that have been included in the index over the past 10 years have outperformed the market by 6.4% for the period of 20 days prior to the announcement.

Investors can generate an even fatter return if they also shorted stocks that will drop out of the stock index.

It is actually not too hard to work out the likely winners and sinners as the methodology used by Standards and Poor’s (S&P) is pretty well understood. It includes a few criteria such as market capitalisation and liquidity.

This is why it is funny how this phenomenon works as it actually runs against classical financial theory that arbitrage opportunities don’t really exist, especially not on a regular basis.

This is because if the market knows of a pricing mismatch about to occur, market participants will move to capitalise on the anomaly, and that behaviour will correct the arbitrage.

Perhaps it’s the growing popularity of exchange traded funds that passively track an index that makes this arbitrage work. These funds can only buy the newly included companies and sell the castaways after the fact.

Whatever the reason (and assuming Morgan Stanley analysis is on the money), investors have a chance to generate some “alpha” right now.

Stocks that are likely to be new members of the top 200 stock index, as nominated by Morgan Stanley, includes: infant formula maker Bellamy’s Australia Ltd (ASX: BAL), human resource services company Smartgroup Corporation Ltd (ASX: SIQ), education services group Idp Education Ltd (ASX:IEL), large-format retail property investor Aventus Retail Property Fund (ASX: AVN) and listed private equity group Blue Sky Alternative Investments Ltd (ASX: BLA).

The broker thinks these inclusions will replace the following five stocks: media and entertainment company HT&E Ltd (ASX: HT1), department store Myer Holdings Ltd (ASX: MYR), agri-business Australian Agricultural Company Ltd (ASX: AAC), personal care and hygiene products company Asaleo Care Ltd (ASX: AHY) and real estate investment trust IRON MOUNTAIN INCORPORATED CDI (ASX: INM).

Looking at the S&P/ASX 100 (Index:^AXTO) (ASX:XTO), possible new members are health insurer NIB Holdings Limited (ASX: NHF) and waste and recycling services company Cleanaway Waste Management Ltd (ASX: CWY); while the potential losers are telco Vocus Group Ltd (ASX: VOC) and newspaper publisher Fairfax Media Limited (ASX: FXJ).

Meanwhile, the experts at the Motley Fool have also nominated stocks that are well placed to outperform in 2018 and beyond.

Click on the link below to get your free report on these stocks and to find out why they should be on your watchlist.

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Motley Fool contributor Brendon Lau owns shares of Vocus Communications Limited. The Motley Fool Australia owns shares of and has recommended Vocus Communications Limited. The Motley Fool Australia has recommended AVENTUS RE UNIT and NIB Holdings Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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