Exclude with Impunity: Personalized Indexing and Stock Restrictions

Abstract

Using simulated historical backtests, we study the impact of stock exclusions on the performance of passive and active portfolios. We find that at low to moderate numbers, stock exclusions have very little influence on passive portfolios. Their effects on active portfolios vary by the factor in consideration and the portfolio construction method, but the magnitudes are much smaller than suggested by the percentage of stocks being excluded. We find similar patterns with industry-concentrated exclusions. Overall, our results suggest that investors should feel comfortable excluding a fairly large number of stocks before experiencing any significant deterioration in their investment performance.