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Investors brace for annual Russell index rebalancing with pandemic imprint

Stock MarketsJun 18, 2021 02:26PM ET
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© Reuters. FILE PHOTO: Traders are seen at work at Northern Trust offices in London, Britain August 1, 2019. REUTERS/Toby Melville

By Chuck Mikolajczak

NEW YORK (Reuters) - Market participants are girding for probably the biggest trading event of the year next Friday, as FTSE Russell stages the final reconstitution of its indexes, and trillions of dollars in investments could be influenced by the event that will reflect a wild trading year marked by the pandemic and the "meme" stock craze.

On the last Friday every June, FTSE Russell refreshes the components in its range of indexes, such as the Russell 2000 index of small-cap stocks and Russell 1000 index of large-cap names. Together they make up the Russell 3000 index. There are also style indexes such as the Russell 1000 growth and Russell 2000 value.

It is often the heaviest trading volume day of the year, as investors and fund managers scramble to buy or sell shares to dozens or even hundreds of companies to reflect changes in indexes. Many this year will be watching "meme stocks" like GameStop (NYSE:GME) or AMC Entertainment (NYSE:AMC) whose value soared. Companies that went public through mergers with a Specialty Purpose Acquisition Company (SPAC) will also be on the radar.

As of the end of 2020, about $10.6 trillion in investor assets was benchmarked to Russell's U.S. indexes, according to FTSE Russell.

While FTSE Russell has occasionally tweaked its rules for inclusion in its indexes, such as allowing companies with multiple share classes to remain in or be permitted for inclusion, this year's reconstitution has no methodology changes.

"Our policy team obviously regularly talks to the market participants and our committees and there were no new rules identified that were needed," said Catherine Yoshimoto, FTSE Russell Director of Product Management.

Market capitalization for the Russell 3000 index vaulted from $31.4 trillion in 2020 to $47.7 trillion as of Russell's "rank day" on May 7, 2021.

Stock market volatility took the index on a wild ride in the past two years. In early 2020, stocks sold off when the pandemic hit but then rebounded late in the first quarter to remain about flat from the previous year. This year the market cap for the index surged as stocks have rebounded along with vaccine distribution and a reduction in pandemic-induced lockdowns.

Graphic: Performance of Russell indexes between rank days - https://fingfx.thomsonreuters.com/gfx/mkt/bdwvkxwndpm/Pasted%20image%201624033482199.png

"It’s more assets, more appreciation, you’ve got some stocks that have gotten bigger weight changes so they are going to see more trading volume because there is jumping around, so this is a bigger trade this year than it has been in previous years" said Steve DeSanctis, equity strategist at Jefferies (NYSE:JEF) in New York.

The market cap breakpoint Russell uses to determine inclusion in the large-cap Russell 1000 or the small cap 2000 also increased to $5.2 billion in 2021 from $3 billion in 2020.

Perhaps no group of stocks exemplified the pandemic trading environment more than the so-called "meme stocks" such as GameStop and AMC Entertainment.

Shares for those companies had languished and even been shorted by many institutional investors due to poor fundamentals. They took off like a rocket as retail investors using commission-free trading services looked for places to invest government stimulus checks.

The market cap of AMC, for instance, stood at $4.3 billion on the May 7 rank day, but has surged to over $30 billion by June 17, well above the top end of the market cap band for the Russell 2000 index of $7.3 billion set by Russell.

GameStop is expected to graduate to the Russell 1000 large cap index. Managers who have chosen not to own those stocks prefer they stay within the index so as not to disrupt their performance versus the benchmark.

"Where those stocks move will dictate a lot of active manager’s relative performance over the following six, eight or 10 months after the rebalancing," said Keith Buchanan, senior portfolio manager at Globalt in Atlanta.

"I would rather have AMC in the benchmark because obviously since I don’t own it I think it is overvalued." Therefore, if AMC falls, his investments would look better against the benchmark.

Goldman Sachs (NYSE:GS) expects 255 additions to the Russell 3000 and 295 deletions, and expects 57 stocks will enter the Russell 1000, including 34 currently in the Russell 2000. Goldman anticipated a total of 279 stock will enter the small cap index, comprised of 232 new components and 47 being knocked down from the large cap index.

A big portion of expected adds will be companies that went public through a merger with a SPAC. Jefferies' DeSanctis estimates over 25% of additions to the Russell 3000 are SPAC companies.

"It is the year of the SPAC, the year of the meme stock - and here they are having ramifications on real money," said Ross Mayfield, investment strategist at Baird in Louisville, Kentucky.

During the event every year, volume surges near the close, often resulting in the biggest trading volume day of the year. The Nasdaq and New York Stock Exchange have contingency plans for the event.

KBW analyst Melissa Roberts expects the bulk of passive fund trading related to the reconstitution will occur in the last 15 minutes or so of the session and estimates the net trade will total nearly $75 billion.

"Let’s face it, for the New York Stock Exchange - Russell reconstitution, from a trading standpoint, is the greatest show on earth, that’s where it all comes down," said Gordon Charlop, a managing director at Rosenblatt Securities in New York.

Investors brace for annual Russell index rebalancing with pandemic imprint
 

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