By Chuck Mikolajczak
NEW YORK (Reuters) - Market participants are beginning to gear up preparations for the annual reconstitution by FTSE Russell of its indexes at the end of June. The event often results in the highest volume trading day of the year.
Recent market volatility has heightened the likelihood for more changes than usual in this year's revamp, although FTSE Russell currently intends to move forward as planned.
WHAT IS THE RECONSTITUTION?
Every year, FTSE Russell reconstitutes, or refreshes, the components in its range of indexes, such as the Russell 2000 (RUT) index of small-cap stocks and Russell 1000 (RUI) index of large-cap names. Together they make up the Russell 3000 <.RUA> index. There are also style indexes such as the Russell 1000 growth (RLG) and Russell 200 value <.RUJ>. FTSE Russell says more than $15 trillion is currently benchmarked to its indexes globally and about $9 trillion to its U.S. indexes.
WHAT HAPPENS IN THE MARKET?
While some index providers choose to constantly refresh their indexes in order to keep a fixed amount of components in them, FTSE Russell only reconstitutes once per year, with the exception of adding initial public offerings on a quarterly basis. This once-a-year change prompts fund managers to adjust their portfolios to reflect the new weightings and components. The telegraphed fashion of the reconstitution also creates additional demand for buying and selling stocks as some investors may see the additional liquidity as an opportunity to take advantage of any price dislocations that may result.
This additional trading volume reaches its apex right at the close of the trading session before the reconstitution is final towards the end of June. During the June 2019 reconstitution, Nasdaq (O:NDAQ) said 1.279 billion shares representing $42.59 billion were executed in its "closing cross" in 1.14 seconds across Nasdaq listed stocks.
WHAT IS THE SCHEDULE?
Given the size of the trade and amount of stocks involved, FTSE Russell takes steps to be transparent https://www.ftserussell.com/press/ftse-russell-announces-2020-russell-us-indexes-reconstitution-schedule regarding the rules for inclusion, which are announced starting in May with its "rank day," which determines the market capitalization bands a stock must be within for inclusion. Steps after that include the publishing of preliminary shares and free float information for constituents along with a query period, and preliminary lists of the additions and deletions from the indexes. The list becomes official this year after the close of trading on June 26. Jefferies anticipates the range for the Russell 2000 between $4.1 billion to about $60 million, with the market cap band for the Russell 1000 between $1.26 trillion and $1.5 billion.
WHAT ARE THE RULES/CHANGES?
In years past, Russell announced various rule changes to its methodology which allowed investors to anticipate some stocks that were candidates for inclusion or deletion. One rule change allowed companies with multiple share classes to be included or remain in the indexes, such as Google parent Alphabet (O:GOOGL). Domicile rules dictate that a company will be allocated to a single country, which in the past brought about the removal of Restaurant Brands (N:QSR), the company formed by the takeover of Tim Hortons by Burger King, as it was reclassified as a Canadian company.
WHAT IS DIFFERENT THIS YEAR?
FTSE Russell has not announced any significant rule changes for 2020, reiterating its 2019 rule on suspended stocks, minimum voting rights and equity offerings. And while some index providers delayed their quarterly rebalancing at the end of March due to the coronavirus-driven market volatility, Russell has no current plans to change the schedule, but said they "continue to monitor the environment."
Bank of America (NYSE:BAC) Merrill Lynch anticipates a very high turnover this year due to the volatility, with 42 Russell 2000 stocks moving up to the Russell 1000 and 47 Russell 1000 stocks moving down to the Russell 2000. Some of those names include Zoom Video Communications (O:ZM), Slack Technologies (N:WORK) and Crowdstrike Holdings (O:CRWD), which have risen in price thanks to government lockdowns designed to stem the coronavirus spread, and no longer are excluded because of Russell's rule requiring at least 5% of a company's voting rights to be in publicly traded shares.