At a Glance
- The Russell US Indexes annual reconstitution process is critical to maintaining accurate representation of U.S. equity markets
- The reconstitution is a major event in the U.S. equity calendar, presenting risk management challenges for some and trade opportunities for others
The newly rebalanced Russell U.S. Indexes took effect on June 29. Russell reconstitution is a closely watched annual market event that impacts more than $9 trillion in investor assets benchmarked to or invested in products based on the Russell U.S. Indexes. Countless ETFs, mutual funds and managed asset programs mirror the composition of the Russell U.S. Indexes in their investment funds, structured products and index-based derivatives.
Changes in market capitalization, sector composition, company rankings and style orientation are reflected in the new index composition.
Key features of this year’s reconstitution:
– The market shrank slightly from a year ago, with the total market cap of the Russell 3000® Index down from $31.7 trillion as of last year’s rebalance to $31.4 trillion.
– For the first time ever, there are companies exceeding $1 trillion in total market cap: Microsoft, Apple and Amazon.
– The total combined market cap of the top 10 companies has grown 23.3% since last year’s reconstitution.
– The smallest company in the Russell 2000 at this year’s reconstitution (Limestone Bancorp) now stands at $94.8 million market cap, the first time since 2009 the smallest stock, by market capitalization, is less than $100 million.
The 2020 Russell Index reconstitution underscores a growing gap between the largest and smallest U.S. stocks.
While overall capitalization for the U.S. equity market stayed relatively flat this year, there was a notable divergence between the large- and small-end of the U.S. equity market, driven by the relative strength of U.S. large-caps over the past year. The big got bigger and the small got smaller.
Representing the U.S. large cap market segment, the total market cap of the Russell 1000 Index increased 0.7% from $29.3 trillion as of last year’s reconstitution to $29.5 trillion. While the total market capitalization of the Russell 2000 Index, representing the U.S. small cap market segment, decreased 19.7% from $2.4 trillion as of last year’s reconstitution to $1.9 trillion.
Year-to-year changes in the breakpoint between the Russell 1000 and the Russell 2000, i.e., the market capitalization that demarcates the boundary between large-cap and small-cap sectors, makes a useful gauge of secular growth in market valuations. Reflecting a challenging 12 months for U.S. small-cap shares, the latest reconstitution saw the breakpoint decrease by more than 16%.
Source: FTSE Russell. Reflects data as of May 10, 2019 and May 8, 2020, respectively.
A Difficult Start for the Russell 2000
Many investors consider the Russell 2000 Index to be the most comprehensive indicator of the U.S. economy due to its breadth of industries as well as its constituents’ central exposure to the United States.
After a relatively flat start to the year, the world’s equity indexes declined dramatically during 2020’s opening quarter. The small cap Russell 2000 was hit the hardest among equity indices as sections of the economy were shut down by the pandemic. The 30.6% first-quarter decline for the Russell 2000 was the largest quarterly loss for the small cap index in its more than 40-year history.
As might be expected in a steep bear market, small caps bore the brunt of the decline on both a domestic and global level. The farther down the market capitalization range one went in the U.S., the worse the result. Large caps lost the least, followed by mid caps, small caps, and micro caps.
As we end the annual reconstitution, global markets have observed increasing levels of U.S. small cap market volatility and growing volume in derivatives linked to the Russell 2000.
Amid these historical swings, investors have been utilizing the small cap futures market at record levels, seeking vehicles to enhance portfolio performance and manage market risk. Since the start of the year, we have seen notable increases in volume on Russell 2000 Index-based futures (RTY). For example, average daily volume (ADV) for E-mini Russell 2000 futures have risen by over 53% so far in 2020 versus the first six months of 2019. ADV for June exceeded 277,000 contracts. Average daily open interest in June was over 575,000 contracts; the highest daily average since August 2018.
Source: CME Group
A Significant Driver
The annual reconstitution is one of the most significant drivers of short-term shifts in supply and demand for U.S. equities, often leading to sizable price movements and volatility in individual company names or industry sectors.
The event can create risks for investors who are tracking these indices, but also opportunities for investors seeking to benefit from the price moves which may be created from the reconstitution.