By Mike Coffey
June is a special month for me. I celebrate my birthday, Father's Day and wedding anniversary, all in the sixth month of the year. June also marks a historic event for the markets — the Russell index reconstitution. This will typically mark the stock market's largest trading day. This year, the event is scheduled for June 28th.
Why is the Russell Rebalance such a big event? According to eVestment, over $9 trillion assets track the Russell US Indexes and 67% of actively managed US equity institutional assets are benchmarked to the Russell US Index. This is an event where a week or month's worth of a company's volume can trade in five minutes.
As an IRO, what do you need to know?
Russell begins the process in May. They refine the equity universe, removing companies that are ineligible for the indices — due to size, country, share type, exchange, governance issues, etc. The remaining companies are ranked by total market capitalization. The largest 3,000 U.S. based companies are deemed members of the Russell 3000.
Next, Russell will further segment the group into large cap and small cap indices. The 1,000 largest market caps will be placed in the Russell 1000 and the next 2,000 companies will land in the Russell 2000.
Finally, Russell adjusts the styles of the individual companies. Russell will segment companies into growth and value buckets based on the firm's valuation relative to their peers.
What's the disclosure process?
May is the ranking month. On May 10th, Russell began the process by determining the 3,000 companies that will become members of the Russell 3000.
June is known as the transition month. On June 7th the preliminary lists of additions and deletions to the Russell 3000 are announced. Any updates to these lists are announced on June 14th and 21st.
It is important to note that Russell will not disclose publicly where a company will fall within the indexes. This information is very important and can have a material price impact. Because of potential volume and price implications, most brokers and hedge funds will try to predict the amount of index shares that need to be purchased or sold on the closing bell of June 28th. That's right, index names are not able to buy and sell companies ahead of the rebalance, because that would put their portfolio out of weighting with the current index. As a result, we will see some huge blocks on the close of June 28th.
Examples from last year
Ocean Rig (ORIG) was added to the Russell 2000 in 2018. This stock had an average daily volume of around 190,000 shares. On the rebalance day, ORIG traded over 7.3 million shares and soared nearly 5%, as index accounts scrambled to purchase over 5 million shares on the bell.
Due to a drop in market cap, Tupperware moved from the Russell 1000 to the Russell 2000. On the surface, you would expect this to be a negative event, but because the Russell 2000 is the premier small cap index, it has many more assets tracking the fund than the Russell 1000. As a result, traders were projecting index names would be net buyers of over 3 million shares. On the rebalance day, TUP traded over 6.6 million shares and jumped over 3.9%.
Because of an increase in market cap, Grand Canyon Education (LOPE) moved to the Russell 1000 from the 2000. This is a great accomplishment. LOPE is now one of the largest US based companies. Unfortunately, there are far fewer assets tracking the Russell 1000. Because of this, traders were bracing for index sales of around 2.6 million shares. On the rebalance day, LOPE traded over 5.4 million shares and finished lower by 3.1%.
Free money?
Given these examples, you could look at these big index trades as a way to book some risk-free returns. Investors should look to buy stocks that are being added to the Russell 3000 or moving to the Russell 2000, from the 1000, and sell stocks that are moving out of the Russell 3000 or into the Russell 1000.
In the end, these trades should be considered as nothing more that liquidity events. We can certainly prepare for buy or sell imbalances. However, as a result of these index imbalances, institutions are also looking at these projections and can use the liquidity event, as a way to enter or exit a position, with little price impact.
What this means for IROs
So what should IR professionals do to make the most of this year's Rebalance? I sat down with Q4's IR Partners, seasoned ex-IROs Matt Tractenberg and Karen Greene for their take:
Matt underscores that communication with the C-suite and the Board of Directors is imperative with these types of situations. He explains: "It is very important to get out in front of this data and prepare senior management for possible price impacts." He continues, "if we know that millions of shares are going to be for sale on the close, the senior management team may look to reallocate existing repurchase plan options."
If the stock still comes under pressure, Matt advises reaching out to value names who may have thought that the stock had gotten away from them at higher levels. The potential drop in price may bring some of these names back into the picture. He also recommends that you consider sharing this information with sell-side contacts and large holders. They usually appreciate proactive notes that make them "look smart" in front of their clients.
Karen suggests that new index members celebrate this accomplishment, both internally and externally, with a press release. Afterall, becoming one of the 3,000 largest publicly traded companies is a major milestone. It's essential to share this news with shareholders and employees alike.
Summing things up, the rise of passive investment continues to be a focal point. As an IRO, it's critical to anticipate these major rebalances and understand what it means for your stock going forward. Stock surveillance can certainly help in this endeavor. And a good partner, like Q4, can help you stay in front of all this activity.
Mike Coffey is VP, Head of Solutions Engineering at Q4. For more information on how Q4 can support your stock surveillance, please email Mike at mikec@q4inc.com.
Expert targeting tips: interview with a 20 year analyst and seasoned ex-IRO