Russell index adjustments could produce $40 bln trade flurry

Investors trying to capitalize on the annual tweaks to the makeup of Russell stock indexes may produce a rush of transactions worth over $40 billion in the final moments of trading on Friday, June 26, when those changes are formalized.

The Wall Street summer ritual—often the biggest trading day of the year—occurs when Russell Investments updates the component companies in its Russell 1000, 2000, and 3000 indexes to keep up with the rise and fall of U.S. corporations. Unlike index operators like Standard and Poor's, which adds and removes components throughout the year, Russell reconstitutes its indexes just once.

On Friday, May 29, Russell will rank stocks based mostly on market capitalization for eligibility in its indexes. Investors have been attempting for months to predict which stocks could be affected.

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Over 40 stocks, including GoDaddy and Skechers USA, could be added to the Russell 1000 with a similar number removed, including Abercrombie & Fitch, according to Credit Suisse. Over 300 companies are expected to move into and out of the Russell 2000.

Traders work on the floor of the New York Stock Exchange in New York City.
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Traders work on the floor of the New York Stock Exchange in New York City.

The rally in healthcare stocks over the past year is expected to push a large portion of the sector into the Russell 1000, increasing its weighting in the large-cap index while simultaneously decreasing its hold on the small-cap Russell 2000.

Investment funds with close to $5 trillion in assets benchmark their performance to Russell's various indexes, while investment funds that passively track Russell's indexes have another $835 billion. Those passively-managed funds have to buy and sell shares to match changes in the revised Russell indexes when they go live at the end of June 26.

In anticipation of that crunch, investors place bets ahead of time on stocks likely to be added and cut.

"It's really important, but everybody thinks it's like this obscure inside baseball stuff and they don't realize it affects 98-plus percent of all stocks that trade,'' said Nicholas Colas, chief market strategist at the Convergex Group in New York. That is because even small changes to the index affect the weighting of all of the stocks in the indexes.

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The Russell 1000 tracks the largest 1,000 publicly traded U.S. companies; the 2000 tracks the next 2,000; the Russell 3000 gives Wall Street the broadest glimpse of U.S. stocks.

Companies with market values above $3.4 billion are expected to make it into the Russell 1000, analysts say. They see around $175 million of market capitalization as the lower limit to make it into the Russell 2000.

Chad Dale, director of index research at Investment Technology Group in Toronto, estimates $64 billion worth of shares will change hands on June 26. Convergex, another trading and market research firm, anticipates about $43 billion in trades, around 15 percent less than in the 2014 rebalance.

Russell aims for transparency in order to minimize market disruptions.

"Most market participants are able to anticipate what's coming in and what's coming out. There really aren't many surprises,'' said Rolf Agather, managing director of North America research for FTSE Russell in Seattle.

Russell announces a preliminary list of additions and deletions on June 12, with updates on June 19 and early on June 26. Changes become final after the market closes on June 26.

This year, Twenty-First Century Fox, Comcast, and Viacom are expected to be included in the Russell 1000 as a result of a rule change allowing multiple share classes. (Disclosure: Comcast is the parent company of NBCUniversal and CNBC.)

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That adjustment follows Russell making exceptions for more than one share class of Google and Liberty Global to remain in their indexes following stock splits.

Domicile rules mean Restaurant Brands International, formed out of Burger King's takeover of Canadian chain Tim Hortons last year, is expected to be removed from the Russell 1000 as it is reclassified as a Canadian company. King Digital Entertainment and Delphi Automotive are now expected to be added.

Despite the size and complexity of the trade, many market participants recognize the need to keep indexes current and look forward to an event that generates a large amount of volume.

"It creates a lot of volume, it creates a lot of opportunity for guys to certainly do some business,'' said Ken Polcari, Director of the NYSE floor division at O'Neil Securities in New York. "Hectic is OK, it's not chaos.''