Every year, FTSE Russell creates a family of indexes, called the Russell Indexes, that measure the performance of broad segments of the US equity market. These indexes have become benchmarks for measuring the performance of investment strategies used by institutional investors and portfolio managers.
The main Russell Indexes are the Russell 3000, 1000 and 2000. The Russell 3000 is the group of the 3000 largest US companies by market capitalization. The Russell 1000 and 2000 are subsets of this, consisting of the top 1000 and the next 2000 companies, respectively.
For more than 30 years, the Russell Indexes have completed a “reconstitution” process once a year, where the Russell Indexes are rebalanced based on updated market cap rankings. A stock’s performance throughout the year, relative to similar-sized companies, determines membership in the different indexes.
Why do it?
There is constant change in the size of the companies within the index, causing them to fall out of the definition of their target market segment (small, mid or large). In addition, company valuations may change, resulting in the company no longer fitting into the parameters of a particular index. Periodically, managers will add new stocks to the index, and they will remove those that no longer fit the specific target segment of the market.
What happens?
First, companies are ranked. Companies whose stocks are listed on eligible stock exchanges and who pass investability rules are considered for inclusion in the indexes. This day, referred to as Rank Day, generally falls on a Friday in early May.
Second, typically on a Friday in early June, preliminary lists of additions and deletions to the indexes are
communicated to the marketplace. At this point, people begin to rebalance portfolios to reflect the index components.
Two weeks later, the final changes go into effect.
For smaller market cap companies, breaking into the Russell 2000 is a significant event. Companies and investors should expect to see above-average trading volumes from the time preliminary index lists are announced to reconstitution day. On reconstitution day, typically one of the last Fridays in June, there will be high demand for shares to be added to the index. On reconstitution day in 2017, $47.1 billion and $28.9 billion in US stocks were traded in the closing moments on the New York Stock Exchange and Nasdaq.
Stock Performance May be Affected
A stock’s performance may suddenly change if there are traders who start trading before the index is rebalanced. This can occur if the index provider announces the stocks that will be entering and exiting the index, or if an index’s clear parameters make it easy to predict which stocks will enter and exit the fund. In essence, the traders will buy the entering stocks high and sell off the exiting stocks that at a low.
Conclusion
Every year the rebalancing of the Russell Indexes is one of the most significant volume-driving events for small cap, US equities. Being aware of the timeline of the rebalancing process will help your company prepare for any sudden changes in your stock performance.
Philip Taylor, Associate
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