Relationship between Institutional Neglect and Stock Returns in India

Abstract

Certain securities especially those of small firms and distress firms are generally unsuited to the investment requirements of large financial institutions and hence attract minimal investment by them. As a result these securities may offer a premium as a compensation for associated information deficiencies and / or because of pricing inefficiencies. The phenomenon known as Neglected firm effect has been found to have a strong presence in US stock market. This paper examines whether neglected firm effect exists in Indian stock market. An analysis of 190 companies ( forming part of BSE 500 equity index) over the most recent 4 years period ( 2000-2004) indicates that the stock of institutional neglected firms outperform those of widely held by institutions. This suggests some potentially rewarding investment strategies for individuals and institutions alike. However neglected firm effect vanishes once the portfolios are controlled for size suggesting that neglected firm effect might be a proxy for size effect. No apparent pattern is detected in the relationship between institutional neglect and distress effect. The findings have strong implications for investment analysts, fund managers as well as retail investors who are continuously on lookout for investment strategies that can provide higher than average return on a risk adjusted basis.

Keywords: Institutional neglect, size effect

JEL Classification: G12,G14