Russell rebalance may see highest-volume trading session of the year

Jun. 24, 2022 4:05 AM ETiShares Russell 2000 ETF (IWM), IWV, IWF, IWDLDNXF, IWO, IJRBy: Yoel Minkoff, SA News Editor

Markets Open After S&P Falls Nearly 4% On Monday

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Friday might result in one of the heaviest trading days of the year as FTSE Russell (OTCPK:LDNXF) completes the annual rebalancing of its indexes. These include market cap benchmarks like the Russell 2000 (NYSEARCA:IWM) and Russell 3000 (NYSEARCA:IWV), as well as other indexes based on investment styles, such as the Russell 1000 Growth (NYSEARCA:IWF) and Russell 1000 Value (NYSEARCA:IWD). The popular products are benchmarked to nearly $12T of investor funds, spanning those managed by hedge funds and 401(k) providers to other institutional fund managers and even retail investors. The frenzy of buying and selling saw total trading volume on the day of the 2021 reconstitution top 16B shares, making it last year's busiest trading session.

How it works? Given the volume and number of stocks involved, FTSE Russell (OTCPK:LDNXF) takes some steps ahead of time to be transparent about the movements. The process starts during "Rank Day" in May - which determines the market cap bands for a stock to be eligible for inclusion - and is followed up with preliminary lists in subsequent weeks, before the actual rebalancing occurs on the fourth Friday of June. Funds and institutional investors that track the various benchmarks are forced to scoop up or ditch stocks that are added or removed from the indexes, and it all takes place just moments before the market closes (some traders even seek to trade any price dislocations that could result from the readjustment).

"We've found that fully reconstituting the indexes annually, plus adding eligible [initial public offerings] quarterly and applying daily adjustments maintains the representative nature of the Russell U.S. Indexes while avoiding the unnecessary turnover that a more frequent rebalancing could cause," said Catherine Yoshimoto, director of product management for the Russell U.S. Indexes.

Interesting times: Popular "growth' players in tech, like Meta, Netflix and PayPal, are set to move to the Russell 1000 Value Index (IWD), which is typically a domain reserved for companies trading at a discount to their fundamentals. That's due to the recent price drops of the stocks, which are down 50-70% YTD. Meanwhile, the energy sector is set to see a heavier weighting in Russell growth indexes (IWF) (IWO), with the industry and related shares being one of the only to outperform in 2022. "Growth managers that have not had to pay attention to energy for several years, now have to pay attention to the sector," explained Steve DeSanctis, equity strategist at Jefferies.

Do traders game Russell's index rebalancing? The iShares Russell 2000 ETF (IWM), which based on Russell's small cap index, has significantly underperformed the iShares Core S&P Small-Cap ETF (IJR), which is based on the S&P Small-Cap 600 index, over the last 10 years. See chart. The underperformance, according to Seeking Alpha contributor Ploutos, is due to Russell's rebalancing methodology, which can be -- and is -- gamed by hedge funds every year. As a result, he argues that investors should own IJR instead of IWM.

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