We are fast approaching the time when the market indices get rejigged and new ASX share entrants could outperform.
History has shown that the share prices of ASX companies that are put on the benchmarks tend to beat the market in the weeks prior to their inclusion.
This means there could be a buying opportunity for nimble-footed ASX investors.
S&P rebalancing of the ASX indices
Standard and Poor's (S&P) rebalances the key indices every quarter. This includes the S&P/ASX 200 Index (Index:^AXJO), along with its sister indices like the S&P/ASX 100.
ASX shares that have lagged are usually dropped and replaced by those that have performed well.
This isn't the only criteria for inclusion or exclusion. But you can see why the market tends to watch this event closely.
ASX shares outperform ahead of inclusion
"Our analysis shows that companies that are included in the ASX 200 can generate alpha prior to their inclusion," said Morgan Stanley.
"Since March 2007, inclusions outperformed the market by +7.5% for the period from 20 days prior to announcement up to implementation."
High probability outcomes from ASX index changes
If you also shorted the ASX shares that are booted from the top 200 benchmark, the returns jump to 13.7% on average.
What's more, the chance of success appears high if history repeats. The success rate for outperforming the market is 81% over the 53 rebalance periods that Morgan Stanley measured.
ASX shares to watch ahead of the rebalance
The question is which ASX shares are the likely new members to the club. The broker reckons the Orocobre Limited (ASX: ORE) share price has a good chance.
This isn't necessarily because of its proposed merger with the Galaxy Resources Limited (ASX: GXY) share price.
No doubt the transaction will create a much larger lithium mining group. But even without the merger, both ASX shares (particularly Orocobre) would qualify to be added to the ASX 200, according to Morgan Stanley.
Just as well given the marriage isn't expected to be consummated before August.
"We think that ORE will be added to the 200, as it will have less impact than if GXY were to go in and subsequently be removed post merger," said the broker.
Other potential ASX winners and losers
Other ASX shares that it believes are likely to be added to the index include the Chalice Mining Ltd (ASX: CHN) share price and Uniti Group Ltd (ASX: UWL) share price.
On the flipside, the Appen Ltd (ASX: APX) share price could be the first in the coveted WAAAX group of tech darlings to be unceremoniously dumped.
"APX was the largest to join its affiliated members within the 100 and could be the first to drop out," explained Morgan Stanley.
"APX float-adjusted market cap has fallen to A$1,398mn, well below its 6-month average of A$2,544mn – the value on which its rank is based."
The good news for Appen shareholders is that the broker doesn't rate this as a high probability event.
