This weeks Barron's - Trading Ahead of the Latest Russell Index Rebalancing -" biggest individual stock moves will probably come from thinly traded small-caps that just made the market-cap cutoff"
Trading Ahead of the Latest Russell Index Rebalancing·
By Nicholas JasinskiMay 24, 2019 9:42 p.m. ET
It’s a club all companies want to belong to.
One of the highest trading-volume days on U.S. stock markets each year falls in late June, when FTSE Russell rebalances its closely followed collection of U.S. equity indexes. Changes in market value and other criteria for inclusion mean that dozens of stocks are added or removed from various indexes, including the large-cap Russell 1000, the small-capRussell 2000, and the value and growth subdivisions of each.
With some $9 trillion currently benchmarked to Russell’s U.S. equity indexes, all of this has a big impact on investors’ portfolios.
Russell will release its preliminary list of new indexes on June 7, using May 10 prices to determine the constituents, which allows strategists like Jefferies’ Steven DeSanctis to calculate additions and deletions ahead of time. The actual rebalancing will take place after the market closes on Friday, June 28—also the end of the second quarter.
There’s a meaningful trading opportunity around the event, according to Goldman Sachs strategists. Looking at the Russell 1000 over the past half-decade, they found that newly added index constituents outperformed existing members by a median of 1.5 percentage points from the announcement date to the day before reconstitution, as active managers get a head start on adjusting their portfolios and buy shares.
DeSanctis calculates that more than $1.1 trillion of passive assets in ETFs and other funds are affected. To track the indexes as closely as possible, these funds generally rebalance their holdings on the day of the reconstitution, prompting the annual spike in trading volume. That has provided newly added stocks with another median half-percentage-point bump of outperformance in the past five years, according to Goldman.
This year, DeSanctis calculates that close to 200 stocks will be replaced in the Russell 1000 and 2000. Other than market-cap changes, index additions include newly listed companies like Lyft (LYFT) and Uber Technologies (UBER), which went public just in time to be eligible for Russell 1000 inclusion in 2019.
Bank of America Merrill Lynch predicts that Spotify Technology(SPOT) and Janus Henderson Group (JHG) will be added to the Russell 1000 as a result of being reclassified as U.S. companies by the FTSE Russell, while NXP Semiconductors (NXPI) falls out for the opposite reason.
A good year for tech stocks means that a number of names outgrew the Russell 2000 and will move up to the Russell 1000, including Zscaler (ZS), HubSpot (HUBS), andTrade Desk (TTD), according to DeSanctis’ data. That will drop the sector’s weighting to 13.4% of the rebalanced Russell 2000, from 15.5% currently, falling behind industrials and health care. Financials maintains the top weighting, at 17.9%.
“Given that some of the biggest changes at the sector level occurs in tech, it makes sense that it will see the greatest dollar amount of trading,” DeSanctis wrote to clients this past week. “We estimate that over $5 billion of tech could be for sale by passive investors. On the other end of the spectrum, industrials and health care could see buying of $1.9 billion and $1.2 billion, respectively.”
The biggest individual stock moves will probably come from thinly traded small-caps that just made the market-cap cutoff for Russell 2000 inclusion. DeSanctis highlights additions like MVC Capital (MVC)—a $160 million business-development company—as facing significant buying pressure, thanks to its inclusion in the index. He projects that MVC could see demand for 1.6 million shares, versus an average daily volume of 13,356 shares in the past month.
Other stocks in a similar position include Value Line (VALU) and First Capital (FCAP), while Middlefield Banc (MBCN) and Associated Capital Group (AC) could face heavy selling pressure in excess of their average volume when they’re dropped from the index.