Investors can be forgiven for approaching this week’s rebalancing of the Russell indexes with some trepidation.
This annual event – when billions of dollars in trades will hit all at once – could get heated, given the markets’ tumultuous nature of late and the high-profile problems surrounding Facebook Inc.’s IPO.
“I still think people are concerned that there could be a technical glitch, a delay in the close, that people could get shut out of the trade – it’s always in the back of your mind when you have lots of order flow coming in at the close on any big day,” said Keith Bliss, senior vice-president at Cuttone & Co. in New York.
Russell rebalances its indexes every year to make sure they reflect the shifts in the broader market. A total of $3.9-trillion (U.S.) in assets is benchmarked to the Russell indexes globally.
Both the New York Stock Exchange and the Nasdaq have contingency plans in place should any problems arise during the closing cross. During the 2011 cross, trades of about 750.8 million shares representing $10.6-billion were executed in 1.1 seconds, according to Nasdaq.
The sheer volume of the trade, along with the rough first day of trading on May 18 for Facebook’s initial public offering, is enough to plant a seed of worry for some investors.
Recent rebalances have been relatively pain-free. But in 2001, the Nasdaq was forced to extend its regular trading session due to a network outage.
“At the end of the day, it’s a $30-odd-billion net trade, so it’s a lot of supply and demand. That is unusual at the close,” said Phil Mackintosh, managing director and global head of the trading strategy team at Credit Suisse in New York.
The rebalancing generates a volume jump. Last year, volume on the day of the Russell rebalance was 10.47 billion shares – far above the average daily volume of 7.84 billion shares in 2011 on the NYSE, the Amex and the Nasdaq.
In 2010, volume on Russell-rebalance day was 14.5 billion shares. Average daily volume in 2010 was 8.47 billion shares on the NYSE, the Amex and the Nasdaq.
Money managers who track the Russell indexes must recalibrate their portfolios at the same time to match the makeup of the newly reconstituted indexes.
The final reconstitution is scheduled to go into effect after the close of trading on Friday.
Russell has already posted two previous lists of preliminary additions and deletions, including lightning-rod stock Facebook.
For the reconstitution this year, Russell has made mostly minor tweaks. The firm is excluding companies that produce unrelated business taxable income (UBTI), although the rule is expected to affect fewer than 10 companies.
“It’s much simpler, and that is a good thing because last year was a doozy of a year,” said Lori Calvasina, small- and mid-cap equity strategist at Credit Suisse in New York. “This year, there were a lot of fireworks over UBTI. That ended up not being a big deal in the end.”
By telegraphing the standards for inclusion, Russell believes disruptions in the market can be minimized, making for an orderly close despite the volume spike.
Despite the trade’s size and the potential speed bumps, the Russell rebalancing is lower down on the list of investor worries, considering the global economic environment.
“Investors aren’t focused as much on reconstitution this year because there are so many other things – you’ve got the Greek election, the potential for the fiscal cliff, China potentially slowing,” said Steve DeSanctis, small-cap strategist at Bank of America Merrill Lynch in New York.
One of the bigger changes in this year’s reconstitution is expected to be a change in the investment-style indexes, which are typically either growth indexes or value indexes. Energy-related stocks, because of their recent difficulties, are expected to lose weight in the growth indexes, and gain in the value indexes.
“You don’t want to wake up Monday morning the 25th, and all of a sudden, your energy weight is a lot less as a growth manager and a lot more as a value manager – you don’t want to be blindsided by the event,” Mr. DeSanctis said.