Fund Managers Tracking Indexes Face Biggest Russell Rebalance Since 2007
This year’s changes to stock indexes maintained by Russell Investments may make June the busiest month for managers who track the gauges since 2007.
Russell, based in Tacoma, Washington, estimates that $3.9 trillion is benchmarked to its U.S. stock market measures, which include the Russell 1000 Index of the biggest American companies and the Russell 2000 Index of smaller stocks.
Changes to the indexes unleash trading that can make rebalancing day among the busiest of the year. Last year, 12.8 billion shares changed hands on U.S. exchanges on June 26, the 16th-highest total in 2009, according to Bloomberg data. In the previous four years, volume on rebalancing day was in the top 10. Direct Edge Holdings Inc., which is converting its two U.S. stock trading venues into exchanges, postponed the shift so that it wouldn’t coincide with the index changes.
“Russell 1000 turnover is typically in a range of 2 percent to 5 percent,” said Holly Framsted, who manages exchange-traded funds based on Russell indexes in San Francisco for BlackRock Inc., the biggest manager of such products. “We would anticipate Russell 1000 turnover to be on the higher end of the spectrum this year.” BlackRock, the world’s largest asset manager, runs 16 Russell-based ETFs with combined assets of $60 billion.
Berkshire Hathaway Inc., the insurance and investment company run by billionaire Warren Buffett, may be added to the Russell 1000 after a 50-for-1 stock split on Jan. 21 made the company’s B shares more affordable. The Standard & Poor’s 500 Index added Berkshire Hathaway on Feb. 12, and Russell probably will follow suit, according to BlackRock and index analysts at Citigroup Inc., Goldman Sachs Group Inc., JPMorgan Chase & Co. and Bank of America Corp.
Berkshire’s Class B shares, which traded for $3,340 before the split was announced in January, now fetch $74.41.
Russell altered its criteria for companies incorporated outside the U.S. for tax benefits. Companies such as Covidien Plc, a maker of medical devices, and Tyco International Ltd., the world’s largest maker of security systems, were removed from the Russell 1000 after moving their incorporation from the U.S.
After a similar rule change by S&P, Russell decided to take into account the location of a company’s assets and the primary listing place for its shares, making it possible those companies, as well as Thomson Reuters Corp., Ace Ltd. and Ingersoll-Rand Plc, will be reinstated, according to Investment Technology Group Inc., the owner of the oldest U.S. block- trading system. Russell is scheduled to release a preliminary list of changes today. The rebalancing takes effect after the close of U.S. markets on June 25.
The changes are likely to result in 21 companies being added to the Russell 1000 this year, compared with two last year, according to ITG. Citigroup forecasts a turnover rate for the index of 3.5 percent, the highest since 2007, when changes affected 5.1 percent of the index, according to Russell.
“Turnover is especially larger in the Russell 1000,” said Charles Behette, a director in portfolio trading at ITG in New York. “Less is better” for index managers. “The more turnover there is, the more movement in stocks and the more potential for underperformance or outperformance” of the benchmark.
Including migrations from the Russell 2000, 40 companies may join the large-company index, ITG said, compared with 144 in 2007, according to Bloomberg data.
Berkshire Hathaway, the fifth-largest U.S. company with a market value of $183.5 billion, is expected to account for about 1 percent of the rebalanced Russell 1000, according to BlackRock and ITG. About half of the estimated $11.5 billion Russell 1000 managers will spend to add companies to their funds, will be for Berkshire shares, according to ITG. There was record trading in Berkshire Hathaway shares on Feb. 12, when the company was added to the S&P 500.
“One percent is quite huge, and I think that will really shape the Russell rebalance this year,” BlackRock’s Framsted said.
Berkshire’s inclusion in the Russell 1000 will increase financial companies’ share of the index by about 1 percent, according to ITG, Goldman Sachs and JPMorgan. When the company was added to the S&P 500, financials increased to 15.7 percent of its value from 14.4 percent, according to Bloomberg data. Technology remains the biggest industry group in the S&P 500 at 18.8 percent.
Besides adding and subtracting companies from its indexes, Russell also reclassifies companies as growth stocks, value stocks or blend stocks based on changes in their valuation over the past year.
Six of the 20 biggest U.S. companies are expected to undergo shifts, according to Goldman Sachs. Microsoft Corp. and Wal-Mart Stores Inc., previously classified as growth stocks, probably will become blends, meaning they will be represented in both growth and value indexes. Microsoft is the world’s biggest software company. Wal-Mart is the world’s largest retailer.
General Electric Co., the world’s biggest maker of jet engines, power-plant turbines and medical-imaging equipment, and Chevron Corp., the second-biggest U.S. energy company, may also be represented in growth and value indexes after previously being treated as pure value stocks, Goldman analysts said in a June 4 report.
Exxon Mobil Corp., the biggest U.S. oil company and currently a blend stock, may be designated a pure growth stock, while Wells Fargo & Co., the biggest U.S. home lender, may move to pure value from blend, according to Goldman.
Two companies removed from the Russell 1000 last year because their share prices were less than $1 -- Freddie Mac and Sirius XM Radio Inc. -- are likely to rejoin the benchmark, according to ITG.
The Russell 1000 has fallen 1.6 percent in 2010, compared with the 2.1 percent drop by the S&P 500. The Russell 2000 has rallied 3.8 percent versus the 4.3 percent climb by the S&P SmallCap 600 Index.